Amazon Prime and other Subscription Businesses: How do you Value a Subscriber?


Businesses increasingly don’t just sell products and services in a single transaction. Subscription and other businesses that focus on recurring sales have existed for a very long time. What is new is that many more businesses have adopted a subscription approach, which makes them look a lot more like a company in the the cable television business than an auto parts manufacturer.

Successfully implementing a subscription business model can be particularly hard since the customer acquisition cost (CAC) happens up front and the revenue appears over time. These subscription businesses have a revenue profile that is more like an annuity. This revenue profile is not like the manufacturer’s business that many people learned about from a college introduction to accounting class. Unlike an annuity, the revenue stream of a subscription business is subject to risk, uncertainty and ignorance. The good news is that it is precisely because there is risk, uncertainty and ignorance that an opportunity for profit exists. The bad news is that it can be hard to capture. The reality is that if you do not capture this profit your competitors may do so.

Someone may ask: Why should I worry about this? Will it be on the test? The answer is: Yes and yes. Charlie Munger says it best: “The number one idea is to view a stock as an ownership of the business and to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash-flow than you are paying for. Move only when you have an advantage.” The text in bold in the Munger statement is critical with a subscription service like Amazon Prime- you can’t understand the value of the business by looking at just one month or even a few months since it is lifetime value that matters.

Why are these new subscription businesses being created more often? The economics of a subscription business can be very favorable if you get it right. A lot of financial leverage can be generated if the customer does not need to be acquired repeatedly. Customer acquisition cost is lower for a well-run subscription business even though it is more front loaded. Yes, subscription business models can have more predictable revenues, but that is not caused by the tooth fairy. More predictable revenues are a byproduct of lower overall CAC and some operational approaches and investments in customer retention. The trade-off is that a subscription business model can also be deadly if you get it wrong. Each of the key variables in a subscription business can be either: (1) many angels working together to build something wonderful, or (2) a pack of hungry wolves that can tear the business to shreds. Propelling more businesses to adopt a subscription business  model is a simple truth: if your competitors or competitors get this model right your business may be doomed.

The benefits of this new way of doing business was chronicled well in the book The Outsiders by Thorndike. One of the major innovators of this way of doing business model was John Malone in the cable television industry. Here is John Malone talking about the model he used to build many of his businesses:

“We decided… to go on a cash flow metric very much like real estate. Levered cash flow growth became the mantra out here. A number of our eastern competitors early on were still large industrial companies — Westinghouse, GE, — and they were on an earnings metric. It became obvious to us that if you were going to be measured on earnings, it would be real tough to stay in the cable industry and grow.” “I used to say in the cable industry that if your interest rate was lower than your growth rate, your present value is infinite. That’s why the cable industry created so many rich guys. It was the combination of tax-sheltered cash-flow growth that was, in effect, growing faster than the interest rate under which you could borrow money. If you do any arithmetic at all, the present value calculation tends toward infinity under that thesis.” “It’s not about earnings, it’s about wealth creation and levered cash-flow growth. Tell them you don’t care about earnings..” “The first thing you do is make sure you have enough juice to survive and you don’t have any credit issues that are going to bite you in the near term, and that you’ve thought about how you manage your way through those issues.” “I used to go to shareholder meetings and someone would ask about earnings, and I’d say, ‘I think you’re in the wrong meeting.’ That’s the wrong metric. In fact, in the cable industry, if you start generating earnings that means you’ve stopped growing and the government is now participating in what otherwise should be your growth metric.”

The more you understand about what John Malone has accomplished in his business the more you will understand what companies like Amazon are doing in their business.

To help entrepreneurs, shareholders and lenders understand whether a given business is generating what Charlie Munger called “more value in terms of discounted future cash-flow than it is paying for” it is more than useful to calculate what is known as “unit economics.” I have written a post before about unit economics, but in this blog post I focus more on examples.

Bill Gurley sets the stage:

“[Understanding] the actual unit economics in the underlying business…requires analyzing the ‘true’ contribution margin of the business; not simply looking at gross or net revenue and the proper contra-revenue treatment, and not even looking just at gross margin as defined by the company. Many companies embed costs that are truly variable (for instance customer support, marketing, credit card processing) below the gross margin line. If you want to know if the business model truly hunts, you must pay careful attention. Otherwise, you may have simply found a company that is simply selling dollars for $0.85.”

These five factors determine the “unit economics” of a business:

  1. a customer acquisition cost (CAC);
  2. an average revenue per user (ARPU);
  3. a gross margin;
  4. a customer lifetime (which is a function of customer retention/churn); and
  5. a discount rate.

Let’s work though a key sensitivity using a fictional example. Imagine there is a business with the name “Green Oven” that delivers the food components for cooking meals along with recipes (i.e., food Legos for adults).  Assume Green Oven’s unit economics look like this:

Average revenue per user (ARPU) per month – $110

Gross margin – 33%

Monthly customer churn – 18%

Customer acquisition cost (CAC) – $450

Discount rate – 10%

The lifetime value of a Green Oven Customer would look like this:

LTV prime

That set of numbers above obviously produces an ugly lifetime value. What would happen to Green Oven’s unit economics if the rate of customer churn could be reduced to 7% a month?


Making this comparison (often called a sensitivity analysis) reveals that retention is an important factor for Green Oven. Another important sensitivity to model is the impact of a lower customer acquisition cost (CAC). Let’s take it down to $300 and assume churn is 10% in another sensitivity calculation. The numbers look like this:


It is useful to play around with a lifetime value spreadsheet and do numerous sensitivity runs to get a “feel” for how the variables interact in a given business. In this case of the Green Oven the high CAC makes high churn a potential business killer. Green Oven needs to be laser focused on reducing CAC, so it can better handle churn.

When a business reports an input into lifetime value like CAC or churn it is often an average. That may hide the fact that there are big differences in the analysis by “cohort.” A cohort is a collection of customers who share an attribute or set of attributes. For example, one type of a cohort is those customers who subscribed to a service in a given month.

Managing customer lifetime value for a business isn’t simple as David Skok writes:

“If you’re an early stage SaaS startup, still trying to get product/market fit, or experimenting with different ways to make your marketing and sales predictably repeatable and scalable, it is useful to play around with CAC and LTV to get a feel for where you are. But it’s important to note that these formulae will only yield meaningful results when your sales and marketing process and costs are predictable and scalable. Instead of spending too much time obsessing over CAC and LTV, rather focus your energies on solving the problems of improving product market fit, and making your customer acquisition, repeatable, scalable and profitable.

My apologies that there are some complex looking formulae in this article. We have provided a summary below of the key concepts, and a link to jump straight to the spreadsheet to model your own LTV. For those interested in understanding the theory behind this model, we provide our usual detailed explanation below.”

Making management of lifetime value is hard for an entrepreneur in no small part because the lifetime value variables change based on other factors like the sales channel used or geographic factors. A business can start out with very high CAC and then have it it drop over time (XM Sirius or Netflix) or have relatively low CAC and watch it rises over time (Blue Apron it appears). You can see the impact of these changes yourself by using Skok’s spreadsheet in the link to perform your own sensitivity analysis.

Why might CAC drop? There are many possible reasons including improved core product value over time, less competition, a booming economy and rising incomes, or a better sales funnel. Spending money on a growth hypothesis before a value hypothesis is a classic way to suffer horrific churn. Nothing reduces churn more than a more delighted customer.  Nothing makes it worse the an unhappy customer telling other people about their unhappiness.

  1. “If the dogs don’t want to eat the dog food, then what good is attracting a lot of dogs?” Andy Rachleff
  2. “If you make customers unhappy in the physical world, they might each tell 6 friends. If you make customers unhappy on the Internet, they can each tell 6,000 friends.” Jeff Bezos
  3. “The key is to set realistic customer expectations, and then not to just meet them, but to exceed them – preferably in unexpected and helpful ways.” Richard Branson

Why might CAC rise? There are many reasons this could happen including but not limited to greater competition, a recession, or the need to move into new market segments as the early mark segments become fully penetrated. Amy Gallo writes in a Harvard Business Review article:

“Often a high churn rate is the result of poor customer acquisition efforts. “Many firms are attracting the wrong kinds of customers. We see this in industries that promote price heavily up front. They attract deal seekers who then leave quickly when they find a better deal with another company…Before you assume you have a retention problem, consider whether you have an acquisition problem instead.” “Think about the customers you want to serve up front and focus on acquiring the right customers. The goal is to bring in and keep customers who you can provide value to and who are valuable to you.”

A cohort analysis might look like this when graphically presented (another David Skok example):


In the title of this blog post I said that I would explain how to value an Amazon Prime Subscriber. If you think about Amazon Prime as an annuity (i.e., in terms of lifetime value) it might look like this below:


This LTV calculation for Amazon Prime is based on one set of assumptions by one analyst based on incomplete information. The assumptions for Prime used by this analyst are:

ARPU: $193 a month

SAC: $312

Gross margin 29%

Churn  0.6% (customer life 167 months or ~14 years)

Discount rate 9%

You can use your own variables and David Shok’s spreadsheet (or your own) in conducting a lifetime value analysis rather than relying on Cowen. Not looking at lifetime value at all is a huge mistake. A company like Amazon is not understandable if you believe its business model is similar to the steel manufacturer you learned about in your introduction to accounting class. Trying to value Amazon’s Prime business with a P/E ratio is like trying to open a can of corn with a pickle.

An investor can pretend they do not need to do this lifetime value math, but the result will not be pleasant. Peter Lynch famously said that an investor who does not do research is like a poker player who does not look at the cards. To understand the value of the stock of a company that is using a subscription business model you need to understand the business and you can’t understand a business like Amazon without doing this lifetime value math. I will be writing more on subscription business models in subsequent blog posts.


Bill Gurley

David Skok:

Amy Gallo:

My blog post on the book The Outsiders:

My previous post on Unit Economics:

My previous post on CAC:

My previous post on churn:

A few links

On churn:

On “Green Oven” comps:

How to Create a Successful Business Model in a Dozen Easy Steps [Fake advice! Not possible.]


You can’t create a successful business model in a dozen easy steps. The title of this blog post is fake news or, more accurately, fake advice. This blog post will give you real advice instead.

Successful business models can be created with a lot of hard work, creativity, innovation and especially experimentation, but there are no formulas. Fortunately there are best practices. I have written about business models many times before (for example, my Steve Blank and Eric Ries posts), but in this post I will be making my points more with examples than the usual more narrative explanation.

The best place to start is asking what a business model is and how it is best discovered. The best place to start is with a definition. I like the Mike Maples Jr. definition: “The way that a business converts innovation into economic value.” Steve Blank has his own definition that is also useful: “A business model describes how your company creates, delivers and captures value.” In other words a business must create value within the value chain and it must capture some of that value. Sometimes value is created and delivered by an entrepreneur and yet little or no value is captured by the creator. As an example, Spotify is creating lot of value in its value chain but how much value is it capturing?  The important point is that a business model that does not capture value is not a successful business model. The concept of “capturing value” particularly important since it requires some sort of competitive advantage.  The most common cause of failure is the failure of a business model to have a competitive advantage. In a recent interview Bill Gurley described one critical objective of a business in this way: “What is it that will allow you to protect that business over the long term? That could be a network effect. It could be some kind of scale advantage. But it needs to have something like that.” In the Floodgate Value Stack model I have written about before this is the third layer which they call Business Model Power:

value stack

A business model is discovered rather than precisely planned in advance and then manufactured. A flywheel is often used as a metaphor for this because the business model discovery and maintenance process is based on iteration and feedback. The “build measure learn” process is a feedback loop that never ends as long as the business is in operation. Businesses that stop the business model improvement and maintenance process inevitably die. A paper by Rita McGrath notes:

“In highly uncertain, complex and fast-moving environments, strategies are as much about insight, rapid experimentation and evolutionary learning as they are about the traditional skills of planning and rock-ribbed execution. Modeling, therefore, is a useful approach to figuring out a strategy, as it suggests experimentation, prototyping and a job that is never quite finished.”

Sometimes the discovery process is quick and sometimes it is slow. Sometimes the business model discovery process creates a successful outcome, but very often it does not. Applying the scientific method to the business model discovery process is a proven way to improve and expedite business model discovery. As I said I want this post to be more about illustrative examples than usual, so let’s dive into that process. I decided to pick an example from the early 1990s. Many people have forgotten or do not know that at this time people had no clue about many of the business models that would eventually be created. The big buzz was around the Information Superhighway and services built around television. People might say: “I would have known what was about to happen to business models in the years after 1993.” The answer to that is: “No you wouldn’t.” Businesses whose success seems obvious now did not seem so than. Some of the smartest and best informed people in the world missed these successes completely. Some people got a few things right obviously but even then their views and plans evolved over the years based on feedback. The future in the 1990s and all other periods was discovered rather than predicted. People made a lot of bets in the 1990s and some of them worked out. Some people were better at making bets than others. Some of that was luck and some of that was hard work, perseverance and skill.

One of the best illustrative example of my points is Starwave, a business founded in 1993 which pioneered a number of important internet technologies and business models. The founder of Starwave was my friend Mike Slade, who once said: “The whole concept of Starwave was to take various bets on the future of a wired world.” At that time the “wired world” was the investing thesis of Paul Allen who was Starwave’s primary shareholder. Allen once described his thesis as follows: “We can already see a future where high-bandwidth access to information is cheap, where there is plenty of computing power to manipulate that information, and where most of us are connected. I think the most exciting things happening have to do with content. We have only begun to invent what will be possible.” Wired magazine described this using the hyperbole that typified its writing at the time: “Starwave’s mission is to envision products and services as if bandwidth were infinite and free – in other words, as if there were no technological and financial limits to how titles and services could be produced and delivered.” Slade has described the “wired world” thesis in very practical terms: “Paul’s idea was that the world is going to be connected and we should do something about it.”

The magazine Fast Company described how Starwave’s business was evolved by Slade over the years:

“To their first brainstorming session with Allen, Slade brought eight ideas. The first stemmed from a job he had while in college. Back then, he wanted to be a sportswriter. Working at the local newspaper in the fall of his senior year, Slade would spend hours combing the Associated Press wire for stories and scores. After graduating in 1979, however, Slade changed his mind about sports writing. He pursued an MBA at Stanford and landed a job at Microsoft. But he never forgot those nights reading the sports wire, unencumbered by the limits of a sports section’s page count. ‘I always wanted to do that again,’ Slade said. ‘Everybody should like what I like, right? Of all the things that I could be a proxy for consumer taste on, being a sports fan is one. That was our first idea. We had a bunch of others. But of course the first idea was the best idea. Never fails. Off we went to do things with it.’

Trouble was, they still hadn’t come to terms with a platform. They created a few titles on CD-ROM. That’s the path down which most of the sports world was headed. All the leagues were licensing discs that included stats, video and audio that could be updated online, through dial-up modems. They built a few prototypes for an online site that would be delivered via interactive TV. None of it seemed to lead anywhere. For about nine months, Slade and a staff of almost 100 tweaked and tuned this thing that would deliver a sports wire feed, supplemented and complemented by original content, to home computers. They started negotiating with ESPN about branding it. But they couldn’t figure out how to get ‘it’ to sports fans. ‘We were all dressed up,’ Slade said, ‘with no place to go.’

Frustrated by the holdup, one engineer finally suggested that they put the product on the Internet. More specifically, on the World Wide Web. Slade knew the Web, knew it cold. He had been vice president of marketing for NeXT computers, the company Steve Jobs started after leaving Apple in 1985. The Web was created on a NeXT machine. Slade did not think the Web was the answer. It was ‘nerdy,’ Slade thought, and would never catch on beyond the scientists who used it to share their work. It wasn’t going to be a business. And it certainly wasn’t going to be a business until more people had high-speed connections. The engineer insisted they should do it anyway. Lacking a better plan of his own, Slade took the idea to Allen. “I went to Paul and said, ‘We’re going to build this thing on the World Wide Web, because we don’t know what else to do,’ Slade said, recounting the dialogue. ‘He goes, ‘What’s the business model?’ I go, ‘I have no idea.’ He goes, ‘OK.’”

This is classic example of an entrepreneur who knew that he needed to find “core product value” and “product/market fit” before finalizing the business model. Certainly all  possibilities were considered such as advertising, subscriptions, licensing, and merchandise, but nothing was set at the beginning of the process. Slade would later say: “There is no single plan or model for doing business on the Web because there is no business — yet.” He added on another occasion: “Our strategy was to get out ahead. And run like hell.”

Eventually at least several business models would emerge.  Most importantly Starwave cut a deal with ESPN that included:

“Placement of the ESPNet Sportszone name on the crawl that it would run at the 28- and 58-minute marks of every hour. Glover presented a rate card that showed Starwave was getting most of its money back in advertising on ESPN. In the deal analysis, Allen valued that as zero. ‘I have no idea what this is worth,’ he told Slade. Few did. ‘Turns out it was worth everything,’ Slade said. ‘The first people to run a crawl of a Web site that you were supposed to go to was us and ESPN.’ They made their debut on April 1 with an event at the Final Four in Seattle. Digger Phelps chatted up Allen at the launch party. Starwave gave out 15,000 browser discs at an ESPN booth at the convention center. Starwave never turned a profit on ESPN during the five years of the deal, but it became the bridge toward a larger relationship with Disney, which eventually bought Starwave. Along the way, the two companies charted a course for dot-com success.

It didn’t always proceed smoothly. The first time ESPN tried to sell advertising space on the site, the pitch tanked. Glover went to companies offering six charter sponsorship positions for $1 million each. For that, they’d get … well, to be honest, Glover hadn’t a clue. ‘We were laughed out of the room,’ Glover said. ‘Here, most people haven’t even heard of the Internet. And we wanted $1 million. Needless to say, we didn’t even get close to a sale.’ They did finally sell what some say was the first sponsorship deal on the Internet, to Gatorade, for $25,000. ‘And that was huge,’ Glover said. With the sports ubersite launched, Starwave and ESPN had a template in place. They would pay to develop and operate sports sites, in exchange for a cut of the revenue they brought in. They offered the same deal to each of the four major leagues and to NASCAR.”

To close this blog post it is worth thinking about is happening when a new business model is created. Nick Hanauer and Eric Beinhocker make important points here:

“A capitalist economy is best understood as an evolutionary system, constantly creating and trying out new solutions to problems in a similar way to how evolution works in nature. Some solutions are ‘fitter’ than others. The fittest survive and propagate. The unfit die. The great economist Joseph Schumpeter called this evolutionary process “creative destruction.” And he highlighted the importance of risk-taking entrepreneurs to make it work. Thus, the entrepreneur’s principal contribution to the prosperity of a society is an idea that solves a problem. These ideas are then turned into the products and services that we consume, and the sum of those solutions ultimately represents the prosperity of that society. Capitalism’s great power in creating prosperity comes from the evolutionary way in which it encourages individuals to explore the almost infinite space of potential solutions to human problems, and then scale up and propagate ideas that work, and scale down or discard those that don’t. Understanding prosperity as solutions, and capitalism as an evolutionary problem-solving system, clarifies why it is the most effective social technology ever devised for creating rising standards of living…. If the true measure of the prosperity of a society is the availability of solutions to human problems, then growth cannot simply be measured by changes in GDP. Rather, growth must be a measure of the rate at which new solutions to human problems become available.”

P.s., There are many other examples of business model discovery. The paper by Rita McGrath cited once before above (link in the notes) uses Google to make her points:

“Consider a business model category that we take for granted today – advertising-supported Internet searches. Text-based searching has been with us for decades, used primarily by organizations (such as libraries and police departments) equipped with electronic databases. When the Internet began to expand the amount of information available on line, new entrants promised a more organized way for users to find what they were looking for. The business model most early entrants tried was to be paid for the search itself, assuming that was what customers valued. In an early example (circa 1995), Infoseek tried to get customers to subscribe $9.95 per month for access to its search engines. Only later did players such as Yahoo! come up with the innovative idea of giving searches away for free in exchange for giving advertisers access to their visitors – and only later still did Google invent what is still regarded as the best algorithm for ranking web pages among the major search engines, creating a critical mass of searchers that would be attractive enough to advertisers to delivers the huge profits it enjoys today.

Without disparaging Google’s accomplishments in any way, its current success stems from and builds upon the many previous experimental efforts made by preceding companies. Figure 2 illustrates how the experimental process of discovering a viable business model for Internet searching unfolded over a considerable time. Note that the model shifted conceptually as technological possibilities expanded e from transaction to subscription based models, to ones supported by advertising. And note also how the advertising-supported model gives a first-mover advantage to a firm that is able to achieve critical mass, since it becomes more attractive to both searchers and thus advertisers. 




My post on Steve Blank:

My Post on Eric Ries:

The Mouse that Roared

Starwave Takes the Web

Rita McGrath paper:


A Dozen Things I’ve Learned About Startups from Hunter Walk


Hunter Walk is a partner at the seed stage venture capital firm Homebrew Management, which he co-founded in 2013. He previously was head of consumer product management at YouTube. Walk joined Google in 2003 managing product and sales for their contextual advertising business. He was a founding member of the product and marketing team at Linden Lab, the creators of online virtual world Second Life. Earlier in his career he was a management consultant and also spent a year at Late Night with Conan O’ Brien. He has a BA in History from Vassar and an MBA from Stanford University.


1. “The best businesses are being constructed by founders who have empathy for, or a connection to the problem they’re solving. It’s not about disdain for an industry. We like to see founders who have a real connection to the problem that goes beyond excitement about a market opportunity. Founders need a ‘why’ that is very personal.” “When founders have an empathetic understanding of a market and they are connected to the problems they are solving, it’s a more ‘mature’ approach to a starting a startup.”

While it would seem natural for people to understand the importance of “product/founder fit,” startups are often created by people who do not have a passion or connection to the problem they are trying to solve. Why would anyone start a business they are not passionate about? Well, they may have read that the block chain was a big opportunity or thought that virtual reality was an attractive market and concluded that they should start a business take advantage of those opportunities. What a venture capitalist like Walk wants is an emotional connection to the customer problem. Mark Zuckerberg is an example of a founder with deep understanding of the company’s product and a strong vision on where he wants the company to go. Bill Gates and Steve Jobs both had this same set of qualities. Great chief executives inevitably have help that allows them to focus on being a great CEO. Zuckerberg has Sheryl Sandberg to focus on operating the business which makes him a better CEO. My friend Craig McCaw had John Stanton and Jim Barksdale as managers to do many of the things that Sandberg does.

There are lots of great examples demonstrating why not considering product/founder fit can be a huge mistake. Steve Blank talks about his own experience with this set of issues here:

“I was now a CEO of Rocket Science, and having a great time building the company. Unfortunately, while I had gone through phases of video game addiction in my life, in no way could I be described as even a “moderate hard-core gamer,” which ruled me out as a domain expert. I realized that for the first time in my career I had no emotional connection to my customers or channel partners. I was about 90 days into the company when I began to realize there was something very different about this business. In previous companies I could talk about technology details and how the product features could solve a customer problem. But people didn’t buy video games on features and they weren’t looking to solve a problem. I was in a very, very different business. I was in the entertainment business. There couldn’t have been a worse choice for CEO in Silicon Valley. Alarm bell one should have started ringing – for me and my board.”

A deep understanding of and empathy for the problems faced by the customer and the market increases the probability that the business will find a way to successfully deliver core product value (solve a real customer problems that they are willing to pay for). A founder of a startup needs every advantage they can get given the struggle that are going to go through. There is a reason why so many people call building a business from startup a “grind.” Perseverance is an essential attribute in a founder.

2. “Don’t start a tech company just because you ‘want to do a startup.’ Startups are hard! You have to be mission-driven. Be able to understand the ‘why?’ Why do you want to spend, minimally, several years of your life working on a particular problem? If you’ve personally experienced the problem you’re solving, or are connected to it in some meaningful way, you’re more likely to persevere and adapt through the challenges of starting a company.”

Startups are hard. As Ben Horowitz wrote in his book The Hard Thing about Hard Things, the effort to create a successful business is inevitably a series of struggles. The passion that the founders and early employees have for the customer problem will energize and sustain them through the struggles that a startup must conquer to be successful. People who love what they do create, make and sell better products. This idea applies in life generally and not just in startups. Warren Buffett puts it this way: “You really should take a job that if you were independently wealthy that would be the job you would take. You will learn something, you will be excited about, and you will jump out of bed. You can’t miss.”

Why are startups so hard? As Charlie Munger says, if business and investing were easy everyone would be rich. The unfortunate reality is that in an economy there is always a top- down constraint on the amount of profit that can be earned in the aggregate by all businesses. Yes, the size of the pie can get bigger for everyone if an economy is healthy and innovation is taking place, but statistically we have data that shows that there is a top-down constraint to how quickly that can happen. There are many venture capital firms trying hard to increase the size of the pie and that is quite exciting, but we have a ways to go before we see the results of these efforts. One of the best posts on this issue was written by Fred Wilson and is entitled: “The Venture Capital Math Problem.” It would be great if someone solved this math problem Wilson talks about via innovation and growth but it is not something that we can say has already been proven to have happened.

What do I mean by top-down constraint? Understanding this concept is best conveyed by example. Warren Buffett said something once about a single company that I am going to change to be about a cohort of collections of startups:

Think about a cohort of startups with a combined market cap of $500 billion. To justify this price, they would have to collectively earn $50 billion every year until perpetuity, assuming a 10% discount rate. And if the businesses do not begin this payout for a year, the figure rises to $55 billion annually, and if you wait three years, $66.5 billion. Think about how many businesses today earn $50 billion, or $40 billion, or $30 billion. It would require a rather extraordinary change in profitability to justify that price.

To put the magnitude of a cohort generating $50 billion in new earnings in context:

top 10

New businesses with profits that approximate those generated by a business like Apple, Microsoft, Google and Facebook do not arrive that often. People and organizations have only so much money to spend and competition effectively creates a top down limit on profit. In addition, much of human progress in consumer surplus and generates no profit or even less profit. The economy does not have an unlimited ability to generate new profits to support the income needed by a very large business like Facebook or Google that often. That ability to support new profit streams can be changed in positive ways via innovation and investment, but the historical record is that that power of an economy to absorb new businesses that deliver huge profits to shareholders does not just radically leap ahead. I would be as happy as anyone if this did happen, but some realism about how much the aggregate profit in an economy can scale over a limited period of time is wise. Fred Wilson points out that venture capital is only a small part of the private equity asset class because it has scaling challenges. Venture capital does punch far above its weight in terms of societal benefit, but there are limits to venture capital ecosystem growth that no one has found a solution for yet. My heart is hopeful, but my brain is more cautious.

3. “Write your principles in pen but your strategy in pencil.”

“What is Strategy?” is the title of a famous Michael Porter essay. Porter describes the essence of strategy in a few sentences:

“In many companies strategy is built around the value proposition, which is the demand side of the equation. But …it’s [also] about the supply side.” “If there are no barriers to entry…you won’t be very profitable.” “It’s incredibly arrogant for a company to believe that it can deliver the same sort of product that its rivals do and actually do better for very long.” “Strategy is about making choices, trade-offs; it’s about deliberately choosing to be different.” “The essence of strategy is choosing what not to do.” “Operational effectiveness is about things that you really shouldn’t have to make choices on; it’s about what’s good for everybody and about what every business should be doing.”

Almost anything a business creates and sells can be quickly copied by other businesses and as a result profit will be driven down by competition to the opportunity cost of capital. This is straight up college freshman economics. Increased supply is the killer of value. In other words, without some constraint on supply, price will drop to a point where there is no real profit left. That is why there is so much talk about “sustainable competitive advantage” by people who are actually running a business. People who believe all you need to do to be successful in business is to “make the trains run on time” make me giggle. Creating a sustainable competitive advantage is both rare and hard. Even if you have it you can lose it in a heartbeat. When sustainable competitive advantage is lost by a business it often can be traced to a mistake made five years before.

Regarding the “principles” of a business that Walk should be written in pen Charlie Munger believes: “Firms should have the ethical gumption to police themselves: Every company ought to have a long list of things that are beneath it even though they are perfectly legal. We believe there should be a huge area between everything you should do and everything you can do without getting into legal trouble. I don’t think you should come anywhere near that line.” The bonus says Munger: “You’ll make more money in the end with good ethics than bad. Even though there are some people who do very well, like Marc Rich–who plainly has never had any decent ethics, or seldom anyway. But in the end, Warren Buffett has done better than Marc Rich–in money–not just in reputation.”

4. ‘There’s a big difference in-between ‘smart iteration’ and ‘lack of discipline.’” “Companies which raise too much too early might think they’re de-risking their funding but also may intro a host of other issues.”

“All work and no play makes Jack a dull boy” is a well-known proverb. “All iteration and no discipline will kill Jack’s startup” could also be a proverb. Long-time observers of the startup world often make this same point by saying: “More businesses die from indigestion than starvation.” A pivot is a stomach wrenching shift that should never be undertaken lightly. Similarly, wild goose chases into new areas of business can divert attention for the critical path. Too much cash can be bad for children, adults and startups. It causes people to do silly things. Buffett puts it this way: “Nothing sedates rationality like large doses of effortless money.”

5. “People tend to forget that your company is your first product, and you have to be intentional about building your company before it’s ready to really grow and scale.”

Walk make a a great point here about the importance of people and hiring. The best way to see if someone understands this point is to watch what they do and not what they say. Benchmark Capital’s Bruce Dunlevie is more focused on the strength of the team in a startup than any venture capitalist I have ever met. His sterling record as an investor is proof that his approach can have a huge payoff financially. His close friend Andy Rachleff believes: “When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.” The team you build is the business you build. Being especially intentional about how you build your team is wise.

6. “The only decisions that are reliably bad are those made out of fear.”

If you don’t feel some fear it is a clue that you may be dead. This is a more common condition that some people imagine. It is one thing to be conscious of fear, but quite another to make decisions based on fear. Dale Carnegie said once: “Inaction breeds doubt and fear. Action breeds confidence and courage. If you want to conquer fear, do not sit home and think about it. Go out and get busy.” Not only does refusing to let fear drive your decisions cause you to make better decisions, it makes you happier.

7. “Work with smart people you trust. Over-index to the quality and ethics of your coworkers and you’ll never go wrong. Not only does it increase the likelihood of success on current projects, but those are the type of people who will continue to work at amazing companies over the course of their careers.”

A “seamless web of deserved trust” is one of the biggest advantages a business can have. Trust is vastly more efficient than layers of management and control. Unfortunately, a system based on trust only works if you hire people very carefully. In other words, with great trust comes great responsibility to hire well. That someone is smart, hardworking and successful does not mean that they are trustworthy. Charlie Munger sets out the challenge on this set of issues:

“It’s hard to judge the combination of character and intelligence and other things. It’s not at all simple, which explains why we have so many divorces. Think about how much people know about the person they marry, yet so many break up. It’s not easy, but it is in some cases. If people are splashing around with money like Dennis Kozlowski, with vodka at parties coming out of some body part, and if it looks like Sodom and Gomorrah, then maybe this isn’t what you’re looking for. But beyond that, it’s hard. If you have some unfortunate experiences while getting that knowledge, well, welcome to the human race.”

If you have found you have made a mistake about someone’s character, then change course.

8. “Your organizational culture — especially as it relates to diversity — is established the moment you start a company. Once your team grows, once you have your first twenty employees, it’s very difficult to change a culture. Early hires are your culture.”

What is the culture of a business? I view it as a system of beliefs, mental models, values and principles that drive the behavior and actions of the people who are involved in a business. The best cultures are authentic in every sense. When people know what to do and actually do that when no one is looking at them, a healthy functional culture in place. Culture, like trust, allows the business to be more efficient. It also create a a shared sense of mission that breeds the missionaries that create successful businesses.

9. “The importance of adding an outside investor to your board as early as seed stage is more common now than it was when we started the fund early in 2013, there’s still occasional question about whether this slows down a company’s operations or gives investors too much control. My answer is, if it does, you’ve selected the wrong investors, which is a bigger problem. Our emphasis isn’t on slide decks and governance, but instead on helping founders build leadership, steady cadence and periodic strategic discussion into their thinking, which we believes contributes to startups being more prepared for a successful A Round.”

We all need people who can help us grow as a person and make better decisions. No one has perspective on themselves. Some people are obviously more self-aware than others of course, and some people have zero self-awareness. As an example of a healthy balance, Munger says about Buffett: “Warren’s a lot more able than I am, and very disciplined.” Buffett says Munger is “both smarter and wiser.” Well-chosen colleagues can help make you a better investor, business person and human being. The best venture capitalists roll up their sleeves and stand shoulder to shoulder with founders.

10. “At the seed stage there are just some things you can’t outsource and fundraising is one of them. Having a banker or adviser behind the scenes helping you understand the venture process? Maybe (although there’s so much more info out there these days than 10 years ago). But having this person approach me with an ‘I’m representing Company XYZ which is looking for funding’ email? Not the way to start off our relationship.”

The relationship between founders and their venture capitalists is like marriage in that it must last for many years. Personal chemistry is very important. The importance of doing due diligence on the character of venture capitalists and not just their investing acumen will pay big dividends for any founder and the same is true for venture capitalists doing due diligence on the character of founders.  How do they treat people? Not just people they feel are “important” or that can help them, but everyone. How do the treat their friends and family? How do they treat a total stranger? Are they still around for friends and family when the chips are down or something has gone wrong? Are they kind? Do they have empathy? Do they stand up for what is right?  Do they keep promises? Are they compassionate? Do they pitch in?  Do they walk their talk?

11. “Work on projects that matter. If you find yourself treating your job like, well, a job, you should either figure out how to be more passionate about it, or find a new gig.” 

Life is short. The older you get, the more you should realize that every minute of every day is precious. I wrote in #2 above about how passion will make you more successful, but there is also the fact that doing what you are passionate about will make you happier. Happiness is highly under-rated. Working with people who are happy is also under-rated.

12. “The Bottom Up Economy is about the global transition from an industrial economy to a technology-based one. It means there’s not really a single ‘technology industry’—every industry is being shaped by tech. Out of both opportunity and necessity, new marketplaces, revenue streams and efficiencies are being created.”

Every company of significant size is now a technology company. They are also all software companies. Not everyone must be a programmer, but everyone must understand the importance of and uses of software. While there are still management teams that do not understand the importance of software, they will not be able to survive as managers much longer. Software is eating the world. And the world is eating software.


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How VCs Spend Their Time. Err, How This VC Spends His Time.

You’re Either Venture-Backed or a Lifestyle Business: The Big Lie

Two VCs Interview Me While They Drive: A Transcript

Steve Blank:

Fred Wilson:

A Dozen Lessons I Learned from Bill Gates Sr.


Bill Gates Sr. is one of three mentors I have had that were actually appointed by a group to help me develop as a person. I have had other mentors that I recruited or the relationship just developed. What Bill taught me was not only important but inevitably delivered at just the time I needed the guidance most. Other than my parents, who attended college with Bill and his first wife Mary, no one has had more influence on who I am. I probably never go through a day where I do not think subconsciously at least once: “What Would Bill Gates Sr., do in this situation?” Having Bill Gates Sr. be your mentor is the equivalent of being able to start a career and life at third base. Bloody hell was I lucky. Set out below are a dozen of the many things he taught me.

  1. “I am an optimist.” He is always optimistic and forward thinking. The only time I ever saw him less that fully optimistic was at a lunch right after his wife Mary died. That day at the restaurant he said emphatically as tears poured down his cheeks: “I will never marry again,” which goes to show that he is not always right since he married Mimi Gardner Neill about a year later.
  1. “There’s power in sharing stories.” The holiday card Bill sends each year and the corny poems he traditionally recites at events are all about storytelling. Bill also uses stories when talking to clients to who looked to him for wisdom as much as they did legal advice.  This reminds me of the great story about his son who said after being chided about being slow getting into the car for a family event: “I’m thinking, mother. Don’t you ever think?” Bill once recalled that day in this way: “Imagine yourself in our place. I was in the most demanding years of my law practice. I was a dad, a husband, doing all the things parents in families do. My wife, Mary, was raising three kids, volunteering for the United Way, and doing a million other things. And your child asks you if you ever take time to think.” 
  1. “A start-up business is just virtually 100 percent devotion both in time and energy.” Together with a few other people Bill built both a fine law firm and a solid business. Like most businesses the law firm was not a Microsoft class grand slam financial outcome, but it was a fantastic result nevertheless. The vast majority of businesses are more like the law firm Bill created than Microsoft, Facebook or Google. 
  1. “As conflicts arise between parents and children from common causes, the whole business of exerting independence, fighting against discipline, that’s an experience we had, and it was one that was particularly the case with my son and his mother for a period of a couple of years. It obviously worked itself out at a very early date. An interesting piece of that was the consultant that we went to and talked to about this. Mary and I would go in, and our son would go in and talk to this fellow. This went on for a better part of a year and a half. Toward the end, Mary and I were there for a meeting with him, and he said, ‘You have this war going on with your son — you really should understand that he’s gonna win.'”  Pick your battles and especially your wars.


  1. “Woody Allen said, ‘Eighty percent of success is showing up.’ And, I believe that.  If you’re on a board, a committee of some kind, and you go to a meeting and nobody else showed up… You support causes by showing up and, obviously, participating.”  It is stunning how many boards, committees and groups Bill has participated in over his career. His influence is everywhere you look in Seattle and, if you look at the influence of the Bill and Melinda Gates Foundation, the world.  As just one illustrative example, in the early 1980s he involved me in an effort to move technology from the University of Washington to the private sector. The Washington Research Foundation was organized in 1981 and the Washington Technology Center two years later to foster the transfer of technology from university researchers to commercial businesses. He knew then that it is the positive spillovers a great research university that drives the economic and cultural vibrancy of a city. Having the opportunity to watch him operate in that setting was life changing in terms of developing my skills.
  1. “I believe in the combined power of men and women who ‘show up’ for the people they love and the causes they believe in.” The whole of people’s participation in a cause is worth more than the sum of the parts when it comes to “showing up.” Bill believes that everyone who has been fortunate in life needs to do something to counteract what he calls the “disadvantages that random chance has imposed on others.”
  1. “Society works better when people think less about ‘me and mine’ and more about ‘us and ours’.” “We’re all in this together.” Making this point is best done by looking at two examples. The first example concerns the United Way campaign which is always an important activity in the life of Bill Gates. He understands the power of people helping others in a community. His enthusiasm causes other people to become involved and that snowballs. The second example involves an after work basketball team that I played on with Bill. He played center and I was a guard on that team since I am a full foot shorter than he is  (which is why I always wanted to be like him when I “grew” up). He was an unselfish player more concerned with making a great pass than scoring himself. On this team and in other settings he was always thinking about “us and ours” and not “me and mine.”
  1. “I’ve seen the power of public will to take on and surmount great challenges.” “I don’t care if you carry a banner or if you stand near the back. You can yell into a microphone if you like or you can listen carefully if that’s your style. You don’t need a soapbox to be a good citizen, you just need to be part of the public will to make life on this planet a little better.” How can you say it better than that? When Bill turned 90 years young in 2015 his birthday party held at the University of Washington was attended by many luminaries. Over the course of his career he helped many people and numerous stories were told at that event about his positive impact on their lives. A book of memories was produced for that event in his honor.  In one memorable chapter in that book Howard Schultz wrote that without Bill’s help in dealing with an unscrupulous character he would not have been able to buy Starbucks. If Seattle has a George Bailey equivalent (a lead character in the movie “It’s a Wonderful Life”) it would be Bill Gates Sr.
  1. “I’ve experienced the fear of being poor, the exhilaration of working hard to build a career.” “Dad was very hard-working – he had a partnership in a furniture store, worked very hard, worked long hours. And I learned from seeing that.” “My parents never talked about showing up. They just did it.” There wasn’t a lot of structure to my growing up. I had an awful lot of discretion about where I went, what I did, who I did it with.” The way children are organized today by parents is quite different than what Bill experienced. One thing this upbringing did was force him to learn from mistakes since he had lots of chances to make them. I can’t help think that this experience is a significant part of why Bill has such sound judgment. Bill was on the board of directors of Costco with Charlie Munger who is an advocate of learning from mistakes. Charlie said once: “We look like people who have found a trick. It’s not brilliance. It’s just avoiding stupidity.” Bill contributed to my personal development in many ways not the least of which was the idea of sound judgment. “Ready, aim fire” not “Ready, fire, aim.”
  1. “Hard work, getting along, honoring a confidence and speaking out.” These are the attributes I saw in him as a business leader and community volunteer. He polished each attribute that he learned as a boy scout under scoutmaster Dorm Brahman. He did not forget those lessons. I remember once seeing him tie a fancy knot on a speedboat at his home on Hood Canal (you can take a boy out of scouting, but not take scouting out of the boy).
  1. “You should never demean your child. When you think about the centrality of that, in terms of the relationship with an offspring, you’re off to a really good start.” The centrality of his family in everything Bill does is an inspiration.  The way the family operates as a team is also marvelous to watch.
  1. “For all the rewards of private life, my life would have been much the poorer if I had not experienced those moments when I felt like I belonged to something larger.” There is arguably no organization where he has had more impact that the University of Washington. And the reverse is also true. There is a biographical article about Bill entitled: “Mighty are those that wear the purple and the gold.” He is mighty indeed. Go Huskies!

Biography: Bill Gates Sr. earned his bachelor’s and law degrees from the University of Washington, following three years of military service. A founding partner at Shilder, McBroom, Gates and Baldwin, Gates has served as president of both the Seattle/King County Bar Association and the Washington State Bar Association. He has served as trustee, officer, and volunteer for more than two dozen Northwest organizations, including the Greater Seattle Chamber of Commerce and King County United Way. In 1995, he founded the Technology Alliance, a cooperative regional effort to expand technology-based employment in Washington. Gates also has been a strong advocate for education for many years, chairing the Seattle Public School Levy Campaign in 1971 and serving as a member of the University of Washington’s Board of Regents from 1997-2012.


Mighty are those that Wear the Purple and the Gold

Showing Up for Life

Whitman Commencement Speech–dad–whitman-college-commencement-speech.html

Showing Up

How would Ann Miura-Ko have reacted if Bill Gates had walked into her office in 1975?

Ann Miura-Ko is a Partner at the venture capital firm Floodgate. She is a lecturer in entrepreneurship at Stanford. Prior to co-founding Floodgate, she worked at Charles River Ventures and McKinsey and Company. Some of Miura-Ko’s investments include Lyft, Ayasdi, Xamarin, Refinery29, Chloe and Isabel, Maker Media, Wanelo, TaskRabbit, and Modcloth. She has a BS from Yale University (EE); and a PhD from Stanford University (Math Modeling of Computer Security.)

Since my post from last weekend was about Floodgate’s co-founder Mike Maples Jr., I decided to write about Miura-Ko’s ideas in the context of a specific early stage business I know something about (Microsoft in the 1970s and early 1980s). Miura-Ko’s ideas are, as usual, in bold text and my commentary follows. This post is different in that I am commenting on a specific hypothetical and how Miura Ko’s ideas and approaches might have been applied. This is an experiment and I may or may not do this again.

The thought experiment is as follows: Imagine you are Miura-Ko, had been sent back in a time machine and a 20-year old entrepreneur named Bill Gates walks into your office in 1975. Instead instead of bootstrapping Microsoft’s business like he did in real life, he is in this hypothetical seeking seed stage venture capital.

  1. “The priority as an early stage startup is at the bottom of the stack  —  What is the unique advantage or insight you are building your product on top of? The product/market fit will come later after your key insight of what your unique advantage is.”

The stack Miura-Ko is talking about in the bold text is a key part of the Floodgate investing process which starts at the bottom of this stack below and works up.

value stack

Miura-Ko is saying that at Floodgate the process starts with a careful look at strategy (i.e., whether business might be able to achieve a sustainable competitive advantage). Miura-Ko’s interest in “the unique advantage” of the entrepreneur is directly tied to the “proprietary power” of the business, which in essence is about creating sustainable competitive advantage. If everything that a business offers can be easily replicated by other businesses, then the entrepreneur’s business won’t be very profitable.

Let’s apply Miura-Ko’s process to the hypothetical. What were Bill Gates and Paul Allen thinking about when they formed Microsoft?

They had reached two important conclusions:

  1.  Computers would be owned by individuals; and
  2.  Software rather than hardware was the key to sustainable profit.

To make the investment Miura-Ko would have believed that software rather than hardware was going to be Microsoft’s “unique advantage.”

This focus on software seems obvious now but it was not obvious in the 1970s. I am not saying making hardware is never a good idea, useful to sell software or otherwise valuable but the fateful decision to focus on just software early in the life of the Microsoft business meant that the business was “capital light.” Microsoft never really needed to raise venture capital as a result and did so only once to convince Dave Marquardt of August Capital to join the board of directors. When Microsoft eventually went public years later Bill Gates alone owned nearly 50% of the outstanding shares because the business did not require a lot of externally provided capital to grow.  Microsoft went public when it did only because it had too many shareholders and SEC rules required that it do so.

Strategy is about deliberately deciding to be different and finding unique advantage. Here is Bill Gates describing his thought process in creating a strategy for Microsoft in 1975:

“The original insight for Microsoft was this: What if computing was free? The answer: Individuals would use computers as a tool, and software standards would become the critical element in making this happen.” Fortune, January 16, 1995

Paul and I

“When you have the microprocessor doubling in power every two years, in a sense you can think of computer power as almost free.  So you ask, Why be in the business of making something that’s almost free?  What is the scarce resource? What is it that limits being able to get value out of that infinite computing power?  Software.” Playboy, July 1994

This is from ~ 40 years later (June 2017):

40 years

The analysis by Gates that resulted in a focus on software was microeconomics linked to an observation about technology. That is was done by someone his age at that time is history was amazing.

  1. “If you are asking if you have product/market fit, you do not.”

A business that spends most of its time desperately trying to keep up with customer demand and has a scalable business model has found product/market fit. This is the part of the stack that Floodgate refers to as Layer 2 (Product Power).

The history of Microsoft again is an interesting example of product/market fit. It was in 1975 that the MITS Altair 8800 appeared on the cover of Popular Electronics and inspired Gates and Allen to develop a BASIC language for that device. In 1975 Microsoft revenues were only $16,005. Would that have been enough to get Miura-Ko to invest in Microsoft at seed stage? I think so. The bet she made on Lyft supports my conclusion. Here below is Miura-Ko on Lyft:

“I invested in Lyft when it was still a business called Zimride. I invested because they came in and told me a story about how transportation innovation was critical to significant inflection points in the economy and that they believed such an inflection point was on the horizon. (No other transportation startups existed back in 2010 when I invested aside from Zipcar.) They had a hard time raising their Series A as well. It wasn’t until they pivoted into Lyft in 2012 that they started getting proactive interest from investors.” “Zimride was originally a platform for carpooling and they sold this platform to individual Universities and companies. They were making sales but it wasn’t working as a scalable business model. They had customers but it never felt like product market fit. Lyft was just another experiment that the team tried. They were also looking at doing bus routes from SF to Tahoe, renting vans from SF to LA, etc. The thesis for Lyft was — mobile is big and doing ride sharing peer-to-peer (P2P) would be interesting. The big questions for Lyft before they launched was how big of an idea was this and how confident were they in trying this. Normally the founders had been very nice but when they pitched the idea of Lyft they were very intense about it and the board said to go for it and try it. During the first week of Lyft launching (Zimride was still going on) Tommy Leep who worked with us at Floodgate said — “You have no idea how big this is going to be.” He experienced this magical moment while using Lyft and became one of their early power users. ”

The decision about whether to invest in Microsoft would have been easier for Miura-Ko to make in 1978 when Microsoft’s year-end sales exceed $1.3 million. But a seed stage investor in 1995 wouldn’t have known that.

  1. “It’s the business model that matters. If you send me a 50 page business plan, I probably won’t read it. But send me a picture of your business model all the hypothesis that you have around your business model and I’ll take a really good look.”Alexander Osterwalder has a book on business model generation and so there are different frameworks now that exists out there where you can use them to figure out what your business model looks like.”

The third layer in the Value Stack is mostly about development of a solid business model, which is the way that a business turns innovation into value. Did Microsoft have a sound business model? In 1975 this business model question was tricky, because at the time piracy was rampant which caused Gates to write his famous “Letter to Computer Hobbyists” about software piracy. Gates solved this business model problem by licensing the software to hardware manufacturers who could mostly be counted upon not to violate intellectual property laws.  Gates describes his business model as follows (remember in this thought experiment he is 20 years old and this is 1975):


“It’s all about scale economics and market share.  When you’re shipping a million units of Windows software a month, you  can afford to spend $300 million a year improving it and still sell it at a low price.” Fortune, June 14, 1993

“We keep our prices low and innovate as fast as we possibly can because we are keenly aware of the large number of companies that are single-mindedly working to displace us in every software category.” Upside, April, 1995

  1. “We have our startups do is they’ll go through each component of a business model. In my mind those would be your users, your customers, your pricing which also includes your customer lifetime, how you do customer demand creation, your sales channel, and then on the backend if your producing something or if you have inventory your whole supply chain that could all your components, design, manufacturing, and inventory warehousing.” “How do the customers view you, what’s your value proposition to them? What’s your value proposition to the manufacturers? What’s your value proposition to the sales channel? How do you do demand creation? What’s the cost of customer acquisition? These are all questions that you should be constantly thinking about. And if the dollars in are not greater than the dollars out, then you need to rethink your business model right then and there.”

Gates might have said to Miura-Ko in her office that day what he would say later in an interview: “Our basic business strategy [is] to charge a price so low that microcomputer makers couldn’t do the software internally for that cheap. One of the bigger early contracts was Texas Instruments, where we bid $99,000 to provide programming languages for a home computer they were planning.” I believe Miura-Ko would have seen the potential of early Microsoft given her track record and investing style.

  1. “In the early stage, a good think to look at is — how good are they at early hiring? And what are they willing to give up to get the best people? One of the companies we invested in has successfully hired great talent at some of the top companies around Silicon Valley, even during this highly competitive market. The way they do this is the founders have spent a lot of time thinking about who they want to hire, how they do interviews, compensation structure, etc. They think about these issues just as much as they think about the product.” “If a company is advertising and posting job postings everywhere — this is a sign the company isn’t doing so well. There isn’t anyone who will advocate for your company like the people who are working there already.”

If you have been reading posts on this blog you have seen me write about the fact that missionaries more successful than mercenaries. There is even one post dedicated to just that issue. This matrix below illustrates why being a missionary can be 100% consistent with seeking high profitability.  The issues are separate.

Seeks high profitability No profit objective
Passionate re the product Missionary (Bill Gates at MSFT) Missionary (Bill Gates at the BMG Foundation)
Not passionate re the product Mercenary Volunteer (paying penance for some reason)

Founders who are not passionate about their mission fail way more often. Lots more. Employees and founders who follow their passion do better in their career. The passion and energy of gates and Allen caused many people to join Microsoft. Gates has several times lauded Steve Ballmer for his ability to hire great employees which allowed the company to scale. The team they built was essential to the company that was created. The more great people they hired, the more people wanted to work there.

  1. “We will only invest if there are thunder lizard ambitions but that has nothing to do with how much they raised upfront.”

There is no question though that the ambitions of Bill Gates were huge. This story from the book Hard Drive about Gates takes place right before he would have visited the office of Miura-Ko in my hypothetical.

“Gates had tried to prepare his parents for the fact that he might eventually drop out of Harvard to form a computer business with Allen. As Mary Gates saw it, her 19-year-old son was about to commit what amounted to academic suicide. …Mary Gates turned to a new friend, Samuel Stroum, an influential and respected business leader she had met during a United Way campaign, for help with her son. She arranged for Bill to talk with Stroum, in the hope that Stroum would convince her son to drop the idea of starting a company, at least for the time being, and continue his education at Harvard. A self-made multimillionaire, philanthropist, and civic leader, Samuel Stroum’s advice was often sought, even by the region’s most powerful movers and shakers… “I was clearly on a mission,” recalled Stroum of the couple hours he spent picking Gates’ brain. “He explained to me what he was doing, what he hoped to do. I had been involved in that industry since I was a young boy. He just talked about the things he was doing… Hell, anybody who was near electronics had to know it was exciting and a new era was emerging.” Gates talked about the vision he and Paul Allen shared. The personal computer revolution was just beginning, he told Stroum. Eventually, everyone would own a computer. Imagine the moneymaking possibilities…. a zillion machines all running on his software. Not only did Stroum not try to talk Gates out of his plans to start a business, but after listening to the enthusiastic teenager he encouraged Gates to do so. “Mary and I have kidded about it for years,” said Stroum, now 70. “I told her I made one terrible mistake—I didn’t give him a blank check to fill out the numbers. I’ve been known as an astute venture capitalist, but I sure didn’t read that one right.”

  1. “While you are an early stage startup it’s ok to incur technical debt. During this time period you really aren’t sure what is going to work and what isn’t going to work — the key should be emphasizing on moving fast and making quick decisions vs. making everything perfect.”

Miura-Ko is expressing a thought similar to Mark Zuckerberg’s idea that a business should “move fast and break things.” But in doing this Miura-Ko knows that some technical debt may be incurred and believes that this is acceptable. Ben Horowitz explained technical debt in his recent book The Hard Thing About Hard Things in this way:  

Thanks to Ward Cunningham, the metaphor ‘technical debt” is now a well-understood concept. While you may be able to borrow time by writing quick and dirty code, you will eventually have to pay it back — with interest. Often this trade-off makes sense, but you will run into serious trouble if you fail to keep the trade-off in the front of your mind.”

Almost every software company that is ambitious gets into a situation where there is some technical debt. When I asked a close friend for a good example of technical debt involving Microsoft he said:

“With MS-DOS Word huge effort was undertaken to port the code to serve the Mac (and then the Windows code base). The debt though was that the data structures were designed for very small amounts of real mode memory and floppy disk space which were not the right assumptions to make for Windows with paged memory and hard disks.”


  1.  “A lot of people get confused because we as a firm also talk a lot about Customer Development, the Lean Startup methodology. And they say, ‘Well how is that consistent with Lean Startups?’ The problem is people confuse lean with small. Lean has nothing to do with small. In fact the amount of capital that you’ve taken has nothing to do with whether or not your ambitions are big or small.  … Lean is not small. Lean is a tactic by which we help our entrepreneurs and the entrepreneurs help themselves in a data driven way figure out how they’re going to iterate their product.”

Bill Gates had to watch cash carefully since in the very early days there was a lot of uncertainty about revenue. When he meet with Miura-Ko in my hypothetical Microsoft would have had $16,005 in revenue and three employees. Gated would eventually go through a cash crisis when MITs stopped being a source of revenue. In an interview many years later the two Microsoft founders described the problem:

Gates: “It could get scary. In our very first contract with MITS, we set them up to sell our BASIC to their customers, rather than us selling to computer buyers directly. We thought it was a good deal because they agreed to make “best efforts” to sell it. But later they decided not to sell to anybody at all because there were so many illegal, free copies of our BASIC floating around, so why try to charge people for it? That really made us mad because we thought it encouraged piracy. We eventually went into arbitration to determine if they were in compliance with the contract. In the meantime we were totally out of money…

Allen: …because MITS was withholding payments from us while the arbitration was going on.

Gates: They were trying to starve us to death. We couldn’t even pay our lawyer. They tried to get us to settle, and we almost did, it was that bad. The arbitrator took nine months to issue his damn opinion. But when it was all over, the arbitrator ripped them apart for what they had done.

Allen: That case really, really scared us. If we had lost, we would have had to start over. Bill would call up his dad for advice. We were on pins and needles the whole time.

Gates: But, you know, through it all, we never borrowed money. I always felt like if we had to, we could have. But we never did.”

Gates would later write in his book The Road Ahead about the impact of that experience:

“After that episode, Microsoft has been perpetually cash flow positive. In fact, I developed a rule: We always have enough cash on hand to be able to run the company for at least a year if no one pays us. The MITS experience, suddenly having no income, made me very conservative, a trait that persists to this day.”

  1. “Nowadays people talk about pivoting as changing the homepage on your website and calling that a pivot. That’s not a pivot. A pivot is when you feel sick and you are going to throw up because what you are working on is such a dramatic shift and you don’t know if it will work or not.” “[As an example] the founders had this dilemma where Lyft was taking off but they still had Zimride going on at the same time. We went for a walk and they asked — what should we do with this other asset we have — should we move people over to Lyft? At the time this was a really difficult decision to make but we decided to move everyone onto Lyft. In hindsight this is a no-brainer decision but you need to understand the founders spent 3 years of their life selling the idea for Zimride, building Zimride, raising money for Zimride, having users for Zimride, and sacrificing weekends / friends / family to try to make this happen. Then you are faced with the realization that what you have been building this whole time isn’t working, but this thing you spent a month on is working. It takes a lot of courage to shut the thing down you have spent all of this time and energy on. I appreciate the courage it took for the founders to move aggressively into Lyft.”

Microsoft never did a pivot. So this is a hard one to put in this thought experiment.  While it was not a pivot, for Bill Gates and Paul Allen a prior business impacted what they would do later at Microsoft:

“While Traf-O-Data was technically a business failure, the understanding of microprocessors we absorbed was crucial to our future success. And the emulator I wrote to program it gave us a huge head start over anyone else writing code at the time. If it hadn’t been for our Traf-O-Data venture, and if it hadn’t been for all that time spent on UW computers, you could argue that Microsoft might not have happened.”

However this example did not involve the gut wrenching shift that Miura-Ko describes.

  1. “As an early-stage investor I’m not in the crazy fray of investing in companies once everyone recognizes the company is on a hockey stick trajectory. It’s my job to recognize the early signs of something interesting.”

I have already said that I believe Miura-Ko would have seen the potential of Microsoft in 1975 and would have made an investment if asked. But that was another time and place. Making early stage bets means a lot of investments will fail. It is easy to look back at a great success and say: “I would have invested in that.” To illustrate, someone who did not see the potential was an engineering student at the University of Washington who worked with Gates and Allen on their Traf-O-Data business had many conversations with Gates and Allen about PCs. He recalls: “The whole concept of having a big clunky PC in your house that just used up room, I thought that was totally dumb. I did not have any foresight into what was really going on. I just kinda fought it in my mind, and said, ‘Nah, this is not going to work.’”

  1. “We have invested in solo founders but the healthier dynamic is to have 2–3 co-founders. Being a solo founder is lonely and you are a prisoner to your own startup — that kind of dynamic can be really bad. Having 2–3 team members you feel much more social pressure to stay in the game and can focus the whole team on a problem, in general, teamwork is a more healthy dynamic. The other problem is there is no superhuman founder, everyone has their own weaknesses. It’s better to round out the edges of your weak spots.”

The early team at Microsoft was amazing. They all just fit together and created this positive feedback loop (lollapalooza) of success. The right people kept arriving at the company at just the right time year after year. When Miura Ko met Gates in this thought experiment there might have been just three Microsoft employees.

In addition to Gates and Allen these people worked at Microsoft in the very early days:

Steve Wood was a programmer who developed a version of FORTRAN for the 8080.

Bob Wallace was a programmer who developed a version of BASIC for Texas Instruments (TI).

Jim Lane was a programmer who was hired to write a DEC simulator for Intel’s new 16-bit chip, the 8086.

Bob O’Rear was a programmer who worked on a translator to turn the 8080 BASIC code into 8086 code.

Bob Greenberg was a programmer who worked on developing TI BASIC.

Marc McDonald was a programmer who worked on converting 8080 BASIC for the NCR machine.

Gordon Letwin was a programmer who developed a BASIC compiler.

Andrea Lewis was a technical writer. Marla Wood was a receptionist/secretary/bookkeeper

Many thousands of key people like Ballmer, Shirley, Gaudette and Maples Sr, would later join Microsoft just to name four. The problem I have about going further with names is that the list is long and if I leave someone out I will make that someone very unhappy. So I will stop at four. The important point is that these people balanced each other well and the whole was more than the sum of the parts.

  1. “Gutenberg was probably one of the first people who ever got venture capital so he had a business partner by the name of Faust and he went out and had this idea around the printing press and he got the equivalent of 5 years’ worth of peasants pay to get started on his business. His series B financing came about when he realized he needed a little bit more financing, so this time he asked for little bit more capital from the same guy and the guy gave him the equivalent of 10 peasants stone built houses. So he went along, made a few more mile stones and then had to go back for a series C financing. And then sure enough he was able to get that and it was the same amount; the amount that would basically pay for 10 stone houses for a peasant. And it turns out that the story ends very sadly. He wasn’t really able to satisfy his investors. His investors as you may have heard from other stories from entrepreneurs an investor gets very anxious, wants to see more milestones, he isn’t sure why this isn’t proceeding and eventually sues and he wins and he’s able to buyout Gutenberg’s portion of the printing store. Gutenberg actually died a relatively penniless man and most people don’t really realize his contributions to the printing press until much, much later. And the history books are then changed to reflect his contributions. Now my story today about investors and entrepreneurs is totally different. I believe actually that this whole relationship between innovators and investors is actually very much switched. The power has shifted to the entrepreneur.”

This is excellent story-telling by Miura-Ko which makes an important point: great founders are what creates Thunder Lizard businesses. Gutenberg was a great founder who did not have a great financial result.  But he did change the world in a very significant way. Capitalism requires failure since that is what drives a better life for society as a whole. The cities that produce that most successful startups and the most innovation do not treat failure as a stigma. Firms like Floodgate and investor like Miura Ko help make that happen. But it is the founders that matter most.







Allen and Gates:

Fortune interview:

Gates Smithsonian Oral History:

Ben Horowitz (The Hard Things About Hard Things):

The Road Ahead:

A Dozen Lessons about Business and Investing I’ve Learned from Mike Maples Jr.


Mike Maples, Jr. is a Partner at Floodgate. Before becoming a full-time investor, Mike was involved as a founder and operating executive at back-to-back startup IPOs, including Tivoli Systems (IPO TIVS, acquired by IBM) and Motive (IPO MOTV, acquired by Alcatel-Lucent.) Some of Maples’ investments include Twitter,, ngmoco, Weebly, Chegg, Bazaarvoice, Spiceworks, Okta, and Demandforce. This is the first time I have written about the son of someone else I previously profiled on this blog. Maples has an M.B.A. from Harvard Business School and a Bachelor’s degree in Industrial Engineering and BS degree from Stanford University. Next weekend I will profile the co-founder of Floodgate, Ann Miura-Ko. Floodgate is an early stage venture capital firm that wants to invest and assist “the iconic companies with the biggest impact. Floodgate backs these Prime Movers before the rest of the world believes.”


  1. “Floodgate uses a framework called the “value stack” [which is] a hierarchy of powers. Each is powerful on its own, but as these advantages are layered on top of each other they reinforce and amplify each other even further.” “We are proud to have been one of the tiny number of firms to have invented the micro-VC space over a decade ago. Back when we got started in 2005, it was very hard for a founder to raise $1M. They had to raise a whole lot less or be de-risked enough to raise $5M from a traditional VC.”

If you have read the work of Michael Mauboussin you have seen him make this point repeatedly: “elite performers in all probabilistic fields all think in terms of process versus outcome. So while our society may be conditioned to focus on outcomes, an emphasis on process makes the most sense for the long haul.” Maples has thought deeply about Floodgate’s investing process and can articulate a clear investing thesis. Floodgate believes that the right “stack” (the co-founders were trained as engineers after all) assembled in the right order will potentially generate value which is far more than the sum of the inputs. The first layer in the Value Stack is Proprietary Power which is when the conditions are right tightly coupled with Product Power (the second layer). The business model layer is next the stack and so on. When all the layers are skillfully put into place in the right order, Floodgate’s thesis is that the value created by the process increases non-linearly. This is an example of what Charlie Munger calls “a lollapalooza.”

Maples is naturally focused on the lower layers in the Value Stack since he is an early stage investor, but even then, the potential for the higher layers must be there and some groundwork done on the higher layers.

Maples depicts the Floodgate stack as follows:

value stack

PROPRIETARY POWER: “is about having a structural competitive advantage is critical for avoiding mindless competition.”

  1. “Whenever I look at a company that says they have a technology advantage, I’m interested in a couple things. One is, just what is the advantage, and why would it be hard to copy? But then the other part of the question is, why now? Why did something in the world change to open the world for this opportunity? [For example] if you’re doing topological data analysis, why couldn’t that have been done five years ago? Why couldn’t that have been done 10 years ago? Well it turned out that computational capacity in the cloud was improving, improving, improving at the rate of Moore’s Law, and eventually converged at a critical point where it became practical.” “The problem with mimetic desire is that it’s the wrong ‘personal operating system’ for coming up with a breakthrough idea — it is by definition an incrementalist view of the world that emphasizes following the rules and outcompeting others, rather than re-inventing the rules and transcending competition.”

Strategy is important at every stage of the life cycle of any business. If investors can’t see a source of sustainable competitive advantage it will be hard to raise a financing round. A startup can easily die an early death without some credible of path to achieving a sustainable competitive advantage. Someone may say: “Wait what does this competitive advantage concept really mean?” What it means is that unless there is some constraint on supply it will increase until profit is equal to the opportunity cost of capital. Here’s an example: Imagine you have a stand selling bananas on a city street. And 26 other people start going the same thing sourcing the bananas from your wholesale supplier. That is an extreme example of zero proprietary power. Maples adds: “The best way to compete is to choose not to.” Strategy is what you do differently than your competitors. It is about choosing what not to do.

If you want to understand more about strategy people like Bill Gurley suggest reading Porter’s book Competitive Strategy.


In his search for proprietary power Maples is looking for a breakthrough idea that re-invents rules and transcends competition. What is it that the business will do that is unique? What rule can it break that others thought it was sacrosanct? This is where thinking different can pay in a huge way once in a while. Thinking and acting different will not always succeed, but when it does: boom!

Maples has said on other occasions that lower costs at seed stage are both good news and bad news. Here is his slide:

up down

Let’s be clear that this is a discussion about startups that are suitable for an investment by a leading venture capitalist like Maples. This post is not about opening a new bicycle repair shop. As will be explained below, a business must have a number of essential qualities to be suitable for a venture investment. To put the challenge in context, only 800 new firms raised a Series A round in venture capital in the US in 2016. While this represents a tiny percentage of overall business starts in that year or any year, a few of these business will have an out-sized impact on society. Can the number of series A investments in a given year go up? Organizations like Y Combinator, 500 Startups and Angel List are pushing hard to change this. I hope they are successful, but we do not know the outcome yet.

  1. “The most valuable businesses in the world are going to be networks. I believe the big companies of the world today, if they don’t position themselves to be network-centric, they will fail. I believe that Tesla is a network centric car company. I believe Apple is a network centric phone company. I believe that the twin powers of Moore’s Law and Metcalfe’s Law are what is going to bring abundance to the world in the next 10 or 15 years.”  “If you’re going to build a network effects business, it’s important to ask yourself, what is my network? What are the nodes of the network? How do they connect with each other? Where are the connections strong? Where are they not strong? Is it a global network? Is it a hub and spoke network? What does it mean for me to be the network operator? Interestingly, network effect businesses have existed for a long time. They existed with the railroads, they existed with canals, they existed with RCA, with records, and TV. They existed with Craig McCaw and McCaw Cellular.”

The factor that creates the most competitive advantage in the business world today is network effects. The increased importance of network effects is explained by what Marc Andreessen calls “software eating the world” (the increased important of software in business value chains). Another multiplier of the importance of network effects is that so many systems and networks are now interconnected. Other factors that can potentially create product power like patents, economies of scale and regulatory advantages are still important, especially when combined with network effects, but they are relatively less important than they were in the past.  I do appreciate the shout out by Maples to McCaw Cellular and Craig McCaw since that is part of my heritage. People in many cases have forgotten how capital intensive the early cellular business was particularity for new entrants and how much money had to be raised in places like the high yield markets to make the business model work. They were not the “capital light” platform businesses that Warren Buffet marveled about at the last Berkshire shareholder meeting.

PRODUCT POWER: “is about achieving product/market fit.”

  1. “Have you ever seen a startup where you’re like, how in the hell could they have been successful? It’s because they met a great market. And sometimes, your product, your market, it just has the magic. You can’t beat customers off with a stick. They just want it. I’ve had this happen to me before, where in spite of the fact that the product just seemed horrible on the surface, it just didn’t matter. People wanted it really bad. Product market fit is more of like a dance between the product and the market. You know it’s like if you ever see two people doing the tango, I look at it like the product is leading the dance, but the market is tangoing with the product. I’ll try to be G-rated in my language, but sort of an intimate sort of back and forth between them. And what I find is that if you want to get the tango right, the first thing is to really identify the market. Large, strong customer desire and the right time. You want to find markets where people gravitate to your idea and want it right now, as soon as possible, even if it’s half done. And then that market pulls the product. When a market pulls a product, this is what it feels like inside the building. Nobody’s debating what the features of the next version ought to be, because they’re like, oh my god. This stuff is flying off the shelves, and our customer needs us to fix x, y, and z. And you’re like, OK well let’s fix it. And so that’s what it feels like when the market’s pulling the product. Whereas where the market’s not pulling the product, the conversations in the building are arguments over, why aren’t those customers smart enough to figure out how awesome our stuff is?”

When a business has discovered genuine product/market fit the business will know it.  The primary focus of the business will be on satisfying demand. If the team is spending all their time adding features, the business has not yet found product/market fit. The best businesses generate organic growth and do not need Herculean spending on marketing and sales.

  1. “Most investors are overly focused on traction right now. The problem with that is it can be gamed in the short term. And even worse, it often instills a mindset of iterating metrics to nowhere. It’s more important to us that the startup has a structural competitive advantage and is on the path to creating a product that blows people away in large potential numbers. I have never seen an awesome product with a fundamental advantage and lots of potentially delighted customers not be able to make money.”

Maples is pointing out that without a proven value hypothesis a decision by a business to proceed with proving they have a solid growth hypothesis is counterproductive since resources are being wasted. Traction with a product that lacks core product value won’t last.  That some investors and business put too much focus on traction at seed stage does not mean that traction does not matter.

Yes, eventfully the growth hypothesis must be proven. Maples once included these benchmarks in a slide deck:


BUSINESS MODEL POWER:  “involves translating a startup’s innovation into attractive profits that can improve rapidly.’

  1. “A business model is the way that a business converts innovation into economic value.” “You just have to discover it, but is there always. And then increasing margins and pricing power are proof that the first two layers are strong. It’s axiomatic that if your pricing power is going down, the first two layers aren’t that strong. Either that, or you’re dumb at pricing. But it’s more likely that you’ve overestimated how compelling your product is or how strong your competitive advantage is. The Business Model Canvas by Alex Osterwalder is good to look at for this. But a lot of what I find about business modeling is it is just intuition. When you get to know the customer really well and what they value, it just seems to work.’

Business models fascinate me since they are all unique and are always changing in an environment that is always changing. They all also must cope with nests of complex adaptive systems. The number of potential business model permutations are endless. How can any game on Earth be more interesting than that?

Maples and a group of people like his partner Ann Miura-Ko as well as Steve Black and Eris Reis clearly talk a lot and share many of the same ideas. The output of this process is interesting since it reflects an engineering approach to creating new businesses. Actually going through the Business Model Canvas by Alex Osterwalder (see below) with real examples is quite an instructional process.


COMPANY POWER “is about avoiding management and technical debt.”

  1. “The common element of Twitter, Lyft,, Okta, Demandforce, Weebly, Chegg, Xamarin, Refinery29, Spiceworks, Playdom, and ngmoco] as startups is that their teams were amazing. They were amazing in their domain knowledge for the products they were building and they were amazing at their ability to ‘McGyver’ great outcomes in harrowing and uncertain circumstances. It’s surprisingly rare for a startup team to be able to execute at the level of speed, urgency, and precision required to build a real company.”

Three essential elements in a startup are team, market and product. Or market, team and product. This is essentially another mental model or stack that is useful in understanding a business. The degree of emphasis varies on the first two elements depending on the venture capitalist.  Certain people and teams in certain situations are capable of amazing feats of creativity. More money is not necessary and in some cases is a hindrance.

Before proceeding to the next quote, a side bar on technical and management debt is perhaps useful. Let’s start with a Wikipedia definition:

“Technical debt (also known as design debt or code debt) is ‘a concept in programming that reflects the extra development work that arises when code that is easy to implement in the short run is used instead of applying the best overall solution’. If technical debt is not repaid, it can accumulate ‘interest’, making it harder to implement changes later on.”

Management debt is incurred when a founder or manager makes expedient, short-term management decisions which have costly long-term consequences. If management debt is not repaid, it can accumulate ‘interest’, making it harder to implement changes later on.

  1. “A lot of the good companies that I’ve seen actually proactively define their culture. And they emphasize what that is their first 20 employees, and then it kind of takes a life of its own. Why do you want that? It’s sort of like when ducks fly south for the winter, you don’t have to tell the ducks in the back of the v, get in the v. They just know. And when a company gets into blitz scaling mode, you don’t have time to tell the hundreds of new employees that you hire, here’s how decisions get made here, here’s what we value, here’s how we make tradeoffs at the margin. They have to be programmed in the DNA of how they participate in the company. Basic management systems. This has to do with just one-on-one meetings, board meetings, team meetings, forecasting frameworks. You know, what gets covered in those meetings, what shouldn’t get covered in those meetings. Just having a sort of a philosophy of that going in can save a lot of time and avoid a lot of management debt.”

The right company culture not only allows a business to scale, but minimize and resolve problems as they arise.  It allows decision-making to be distributed, optimized and expedited. Warren Buffett has written: In businesses, culture counts….Cultures self-propagate. Winston Churchill once said, ‘You shape your houses and then they shape you.’ That wisdom applies to businesses as well.” A partner from the venture capital firm Greylock had a blog posted recently in which they said: “Culture Is How You Act When No One Is Looking.” The title alone makes a strong point. When you are working with people you know and trust, tremendous efficiencies are created. Charlie Munger has said on the importance of culture:

“The highest form a civilization can reach is a seamless web of deserved trust.” “The right culture, the highest and best culture, is a seamless web of deserved trust.” “Not much procedure, just totally reliable people correctly trusting one another. That’s the way an operating room works at the Mayo Clinic.” “One solution fits all is not the way to go. All these cultures are different. The right culture for the Mayo Clinic is different from the right culture at a Hollywood movie studio. You can’t run all these places with a cookie-cutter solution.”

  1. CATEGORY POWER: “is [about] designing and owning a category [so as to make] the business the “Category King” [which] usually capture 70–80% of the profit pool in their markets.”

This is the least important layer for a seed stage business, but as I noted above the potential for this layer is attractive to an early stage investor. In this layer along with the Company Power layer ground work is still being done at seed stage says Maples. Ann Miura Ko describes the Category Power layer this way:

“One thing we have noticed is the best companies will spend the time to create a whole new category in the market for themselves, because they don’t want to compete on other people’s terms. They want to be the only Thunder Lizard on the block. For example, Netflix didn’t start out trying to be a better Blockbuster. They created their own separate category and then completely destroyed Blockbuster. Another example is Starbucks — who would have ever thought people would buy $5 coffees when other coffees at that time was selling for 50 cents. They created their own new category. Category power is the ability for the founders to think about the language of the market they are going into, and how they define this for their company. If they are allowing the existing market to define who they are — we get worried about this.” 


  1. “I’m interested in not just companies that are doing a startup, but companies that are doing something hyper-exceptional. And I was seeking a metaphor to describe these companies. And I wanted it to combine the ideas of being big, adaptable, fearsome, radioactive. And it just didn’t seem right to use a term like ‘disruptive innovation’ or something to academic-y sounding, even though we are in an esteemed academic institution right now. So I came up with this term ‘thunder lizard’ about 20 years ago. And thunder lizards, for those of you who are not familiar with Godzilla, were hatched from radioactive atomic eggs. And this is actually the stage of the market that we, at Floodgate, like to invest in. And so we like to say that our job is to spot radioactive atomic eggs. When we invested in Twitter, they weren’t sure whether they were going to call it TWTR, or TWTTR, or Voicemail 2.0. And when we invested in Lyft before it launched, we had to get comfortable with the legal ambiguity of that service. And so at the time that we see this stuff, it’s hard to even know what it’s going to mutate into. But the goal is to find companies that have radioactivity at their roots. And then they swim across the ocean, and emerge with an attitude. And then they begin to devour their startup competitors right as they hit the beach. And then not long after that, they begin to disrupt even more, swiping holes into the sides of buildings, and then eventually, they attack the incumbents. The incumbents in the market are represented by those trains that he’s eating like sausage links. So now you know what thunder lizards are.” “My job is to spot radioactive eggs and to determine if they have that energy to morph into something, to mutate.”  “Of tens of thousands of companies started a year, 97 percent of the exit profits will likely come from less than ten….the point one percent. Our job is to find the point-one percent. But we have an extra twist. We want to avoid competing in a fiercely crowded landscape of established Series A funds. So we have to find these companies at the crazy, risky, and early time before Sand Hill Road is excited. When we are right, we will be rewarded because we will have been able to invest smaller amounts of money at lower valuations. That’s what makes our math work. So, as a general rule we like to see any startup idea that has the chance to be meaningful enough to be in the top point-one percent. But we try not to be too dogmatic about the areas we are focused on. We believe that knowing the rare exceptional startup when you see it is the more important skill.”

What I like about the term Thunder Lizard and I don’t like about Unicorn is that the “U” word does not refer to a business that has actually generated a financial exit for investors.  The term Unicorn encourages bad behavior. I actually use the term Grand Slam myself and definite that term like Maples does with Thunder Lizard to include an actual financial exit.

Maples says he is looking for “radioactive eggs” that can turn into “Thunder Lizards.” I like his taxonomy since not all startups are eggs that can eventually produce a lizard that is as powerful as Godzilla. There are more “radioactive eggs” today that are possible investments by top tier venture firms. Business formation in this Thunder Lizard category is up. But in the non Thunder Lizard category the numbers are down, This statistic makes the point: “the economy hatched 154,000 fewer new companies in 2014.”  A bicycle repair shop or food tuck are not a radioactive egg. To grow the economy and create new jobs we need lots more new business that are not radioactive eggs.

  1. “The first thing that I like to emphasize to people when they start a company is, start a company that’s worthy of your talents that you think represents the absolute utmost gift you have to offer to this world in your life. Because to be one of those, that’s what it takes. People shouldn’t just be doing a startup. Well, I should back up. If you decide to just be doing a startup, that’s fine. But that’s kind of like the decision to join a nonprofit. Or it’s kind of like a decision to– it’s kind of a labor of love, it may make the world better. But don’t do it because you think you’re going to make money approaching it that way. Because that’s not what the objective function of the industry is.”

Starting a business that has the potential to be a Thunder Lizard is far more of a calling rather than a rational act. Missionaries are far more likely to succeed than mercenaries when the act is not rational. It is impossible to fake the feeling that makes someone a missionary rather than a mercenary.  The founder may fool some of the people some of the time, but in the end the truth will come out. They will eventually hit one of the lows that are an inevitable part of what Ben Horowitz calls “the Struggle” and you will bail out. Hoping that the economics of the venture capital world will bend just for them is a triumph of hope over experience.

People say flying a commercial airplanes is composed of long periods of boredom interspersed with a few minutes of terror. A startup is the reverse: long periods of struggle and terror interspersed with a few minutes terror. Am I exaggerating a bit? Sure, comedy requires exaggeration. Did I often have a weird kind of fun and feel accomplishment when I was helping to build Teledesic? Absolutely. Would a team of mercenaries have been able to do what the team of Teledesic missionaries accomplished? No way. My startup experience give me lots to be humble about. I learned a lot. It was also financially rewarding for me since as I explained in my blog post on Teledesic, early investors and employees received a significant multiple on their investment or stock options. Later investor were not so lucky.

  1. “Bill Gates didn’t need to be in Silicon Valley to start Microsoft. Jeff Bezos didn’t need to be in Silicon Valley to start Amazon. Great companies happen because of great founders, not because of where they are or who the VCs are or any of that nonsense.” “I just don’t believe that VCs animate much. I believe that entrepreneurs animate things.”

There will never be another Silicon Valley. But other cities and regions can create a successful technology-driven economy in their own way. In order to achieve this goal, a city or region must and find its own comparative/competitive advantage. The best way to do that is to create a pool of great founders since venture capital will always follow great founders. As an example, when venture capital started in northern California the venture capitalists had their offices in San Francisco. When the founders moved south toward the Stanford campus the venture capitalists moved to Sand Hill Road. When the founders started moving back to San Francisco so did the venture capitalists. Another example of capital chasing great founders is Benchmark investing in Zillow in Seattle and Snap in Los Angeles. Money will always follow opportunity and the opportunity is created by great founders.

The best single way for a city to create a supply of great founders is to have at least one world class research university. Any city or region that wants to well in a modern economy that does not have a major research university is operating at a serious handicap. There are other things a city can do like having a culture that does not treat failure at trying something hard as anything but a great learning experience. Great K-12 schools, a diverse population and a healthy environment help too. Success feeds back on itself in that great founders inspire and attract more great founders.

One final note relates to the power laws that are pervasive in venture capital. With power laws most values are below average and a few outliers are far above. This means that average figures are close to meaningless. Power laws apply not just the distribution of success of venture-backed companies in a country or globally, but to the success of startups within a city or the success of venture firms operating in a city. For example if you take the “multiple on invested capital” of the top 10% of venture firms in Silicon Valley that MOIC will be far above the average MOIC since the distribution is not a bell curve. If you take the MOIC of the top 1% of venture firms in Silicon Valley, the MOIC will be even higher. In venture capital it is the outliers that matter most. This power law distribution exists in an industry but also within a city.


Dare to do Legendary Things

Slide deck:

Slide deck:


Dare to Make your Startup Legendary

Vantor TV


Thunder Lizards

Forbes interview

Category Kings

Greylock post


A Dozen Thoughts from Charlie Munger from the 2017 Berkshire Annual Meeting

  1. “To make teaching endurable, it has to have enough wiseassery in it. And we do.” “We’ve done a lot of preaching [about investing] to not much effect.” “To the extent you’re working on it, you’re on the side of angels, but lots of luck.”

Munger has tapped into something that makes his ideas both memorable and understandable. He is suggesting in these sentences above that part of his success as a teacher is that he injects a certain amount of “wiseassery” into his delivery.  The dictionary definition of wise ass is: “a person who is irritating because they behave as if they know everything, often in a way that is quite humorous but potentially insulting.” While a wiseass may be an effective teacher, Munger once suggested that he does not make for a good role model since what he says is often too controversial which can create significant problems. But the world would be a dreary and less interesting place if there wasn’t someone in it who said things like:

“I don’t think I’m a good example to the young.  I don’t want to encourage people to follow my particular path. I do not want a proctologist who knows Schopenhauer, or astrophysics.  I want a man whose specialized.  That’s the way the market is.  And you should never forget that.  On the other hand, I don’t think you’d have much of a life if all you did was proctology.”


“You do not want your first-grade school teacher to be fornicating on the floor or drinking alcohol in the closet and, similarly, you do not want your stock exchange executives to be setting the wrong moral example.”

To be a wise ass in public in the cause of educating the public requires a rather thick skin, which Munger clearly has. His willingness to say the truth out loud is a needed antidote to somethings that are wrong in the world today. Munger has also said that what brought he and Warren together as friends and business partners Munger was that they are both “natural wiseasses.  I’m not the only wise ass in the world. Warren can find another one.”

Teaching people anything, particularly about investing, is hard. Charlie has said that he has trouble getting his own family to follow value investing principles so he has little hope of his ideas being widely adapted. I think Munger understates his influence, but it may be true that he has helped more people improve the way they think than the way they invest. One final Munger thought on teaching is: “I think the only way you’ve got a chance is sort of by example. If you want to improve your grandchildren the best way is to fix yourself.”

One last point here I can’t resist. I know a blogger who Tweeted recently that he was responding to “hate mail.” He is a nice fellow who is trying to teach people a few things. That people are sending him hate mail is bullshit. Debating ideas is one thing but hate is quite another. People who are haters are often making up for something. like being teased in middle school for having small hands.  The unfortumate reality is that you need to either have think skin like Munger or quit blogging/ tweeting/writing. “Haters gonna hate” is the sad truth.  It is an advantage to not give a damn what people say. I like this from Felicia Horowitz:


  1. “A life properly lived is just learn, learn, learn all the time.” “If we had stopped learning, you [Berkshire shareholders] wouldn’t be here – you’d be alive, probably, but you wouldn’t be here.” “There’s nothing like a personal, painful experience if we want to learn, and we certainly have had our share of it.”  “There’s nothing like the pain of getting into a lousy business to find a good one.”  “We were young and ignorant then; Now we’re old and ignorant.” “Experience is like eating cockleburs – it really gets your attention.” “It is a good idea to not play where the other people are better.”

You may or may not know that a cocklebur is one of these little spiked seed pods that may attach itself to your shoes, socks or clothing, especially if you enjoy walking in riverbeds or pastures. I don’t think I have ever mistakenly eaten one, but I expect that it would not be pleasant. When you read the Munger quote if you found yourself wanting to know (or make sure you knew) what a cocklebur was, you are more likely to be a learning machine. Munger is pointing out that one very effective way to be a learning machine to pay close attention to your own mistakes. If you are not making some mistakes you not learning. The same thing goes for making too many mistakes that are not new mistakes. He also believes that if you are not changing your mind on some important questions each year you are not learning either. Munger believes: “Learning has never been work for me. It’s play.” Life gets better if you adopt this approach to learning.

  1. “The investment world has gotten tougher. Maybe now we have small statistical advantages, when before it was like shooting fish in a barrel.” “We can’t bring back the low hanging fruit; we will have to reach for higher branches.”

 Anyone who doesn’t realize that more competition has arrived in the investing world isn’t paying attention. The more widely held the asset class the more intense the competition has become. This is not new but the trend seem to have accelerated. It is hard to imagine that it was possible in the days of Ben Graham to buy companies at less than liquidation value. As just one example of how investing has become more competitive, Michael Mauboussin writes:

“Exhibit 1 shows that the standard deviation of excess returns has trended lower for U.S. large capitalization mutual funds over the past five decades. The exhibit shows the five-year, rolling standard deviation of excess returns for all funds that existed at that time. This also fits with the story of declining variance in skill along with steady variance in luck. These analyses introduce the possibility that the aggregate amount of available alpha—a measure of risk-adjusted excess returns—has been shrinking over time as investors have become more skillful. Investing is a zero- sum game in the sense that one investor’s outperformance of a benchmark must match another investor’s underperformance. Add in the fact that in aggregate investors earn a rate of return less than that of the market as a consequence of fees, and the challenge for active managers becomes clear.”


  1. “An expert who is really good at money management suffers terrible performance problems when he gets more money in.” “In the future, with our present size, in terms of rates of return will be less glorious than the past we keep saying it now we are proving it. But it is still a collection of businesses on average that has a better investment return than the S&P 500.”

Munger: “It’s a lot harder now (with $90B in cash to deploy).”

Munger: “$150B is probably too big for us.”

Buffett: “We both would do a very big deal.”

Munger: “We don’t have to agree perfectly.”

Buffett: “If we found a deal that makes compelling sense, we would do it.”

Munger: “Now you’re talking.”

Investing large sums of money a market like we are in now is particularly hard. That is why some fund managers return cash or keep funds smaller that they could raise relative to demand.  Warren Buffett’s friend the famous investor Bill Ruane said once: “Staying small is simply good business. There aren’t that many great companies.” It is beyond question that the size of the portfolio is a drag on performance.  The bigger the fund the harder it is to outperform. Buffett puts it this way: “Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money.”

  1. “The first rule of fishing is to fish where the fish are, and the second is don’t forget the first.” “We’ve gotten good at fishing where the fish are. There’s too many boats in the damn water, but the fish are still in it.” A good fisherman can find more fish in China; it’s a happier hunting ground.”

Munger loves fishing and fishing sayings. There are of course other fising sayings like “fish or cut bait” and of course his story about visiting the tackle shop. William Safire in his Political Dictionary wrote:

fish for votes

The tackle shop story? Chris Davis tells it here in this one minute video:

As an aside, in Wisconsin, populations of silver pike have been reported in Munger lake in Oconto County.



  1. “I do think the Chinese stock market is cheaper than the American market. China has a bright future.” “Too many people believe in luck and gamble, and that’s a national defect.There will be growing pains of course.”

Munger said that China was not an easy market to invest in due to opaque financial reporting but it is a better place to find bargains still. Munger said: “One of the things we got into [in China] was the Shanghai airport, the main airport in China, with no debt net. How can you lose owning the main airport in China? It takes extra work. But why should it be easy to get rich?”

  1. “If all [a business owner] cares about is getting highest price, we are not a good call. We can offer happiness to a person who sells us the business. He will have lots of money and be doing what he loves doing while leaving family and employees in the best possible position. This is not the equation of many people who buy businesses borrowing everything they can and resell after dressing up the accounting.” “Don’t call leveraged buyouts private equity – that’s like a janitor calling himself chief of engineering.” “We do well, because people don’t want to sell to those guys.” “There is an army of people in finance and shadow banking who are leveraging these deals with liberal leverage and of course they pay very high prices and they get part of the upside and they don’t take any of the downside and they get fees off the top. So it is fee driven buying and it is very extreme.  Of course, it makes it hard for us to buy companies.

People who sell businesses to Berkshire are rich enough that they have more money than they will ever need. Berkshire gives the selling owner the chance to make sure that the business they care about and the people that work there continue to thrive. For this reason, Berkshire gets offered the opportunity to buy businesses at very attractive prices. Warren Buffett said in the most recent shareholder’s meeting: “Private equity firms buy businesses, but they’re looking to sell those holdings down the road.”  To reassure selling owners, Warren Buffett holds on to businesses even if returns are less than stellar. Here’s Buffett on this point:

“You would not get a passing grade in business school if you put down our principles for why we keep some businesses, but we made a promise. If we don’t keep our promise, word would get around. We list the economic principles, so managers who sell to us know they can count on it. We can’t make some promises, and we don’t promise never to sell. But we’ve only had to get rid of a few businesses, including the original textile business. We also let managers continue to run their business. We are now in class that is hard to compete with. A private equity firm won’t be impressed by what we put in the back of our annual report. People who are rich and run a company their grandfather started –they don’t want to hand it over to a couple MBAs who want to show their stuff. As long as we behave properly, we will maintain that asset, and many will have trouble competing with it.”

 8. “If things go to hell in a hand basket and then get better later, we will do better than others. We are good at navigating through that kind of stuff.” “When the rest of world is fearful, we know America will come out fine. We won’t put the company at risk. We’ll grab all the opportunities we can without losing sleep.” “Fear spreads like you can’t believe, unless you’ve seen it.” “Everywhere you look in Berkshire Hathaway someone is being sensible. Combine that with being very opportunistic so when some panic or something comes along it’s like playing a one-hand sport with two hands.”

Buffett and Munger don’t time markets but they do buy more companies when they are undervalued and buy less when market are high.

daily j

 9. “What was done [at Amazon] was very difficult; it was not at all obvious that it was going to work as well as it did. Other things were easier, and we screwed those up. I don’t regret missing it – I do with Google. We’ll miss out on more, but that’s our secret – we don’t miss out on them all.” “You can read Bezos’ annual report in 1997, and he lays it all out. And he has done it and done it in spades. It just always looked expensive.”  “We are sort of like the Mellons – old fashioned folks who’ve done right, and Jeff Bezos is a different species.”

When asked in a press interview why he did not buy Amazon shares Buffett said on CNBC:


 10. “It’s a very good thing that Warren bought Apple. Either he’s gone crazy or is learning. I prefer to think he’s learning.” “The world has changed a lot, and people who’ve gotten into these [capital light] businesses have done very well.” “Now Warren did run around and take his grandchildren’s tablets away for market research.” “We failed you [on Google]. We were smart enough to do it and we didn’t.”

At Munger and Buffett he used their error of omission on Google to illustrate how you can learn from experience. Buffett said:


Buffett said, “The five largest market cap companies in America are worth $2.5 trillion and require no equity capital. That is an extraordinary change from the past,


  1. “A lot of other people are trying to be brilliant and we are just trying to be rational. Trying to be brilliant is very dangerous, particularly when gambling.”   

My post on this is: A Dozen Things I’ve Learned from Charlie Munger about Making Rational Decisions

 12. “We don’t want to go back to subsistence farming. I had a week of it and hated it growing up. I also don’t miss the elevator operator sitting there with a crank.” “No one ever complained about the advent of air conditioning. I am worried more about the change not being fast enough.”

Productivity getting better is what makes the quality of a person’s like get better. Munger believes that what we need to realize is that people get hurt by this shift and we need to help them make the transition. One of the more impressive arguments I have seen on issues related to productivity and innovation set of issues was made recently by Marc Andreessen.  Marc said:

“There are two very different parts of the economy. There’s the part where there’s rapid technological change and very rapid productivity improvement. You’ve got this other, second part of the economy that’s the exact opposite — where quality is not improving and prices are rising.” “The economy has bifurcated. In high productivity sectors, prices are crashing. The sectors where prices crashing are shrinking as a percentage of the economy. TVs are going to cost ten dollars and health care is going to cost a million dollars.” “The rising cost of a modern college education is just staggering. In the industries where there’s rapid productivity growth, everybody is freaked out, because what are people going to do after everything gets automated? In the other part of the economy, that second part, health care and education, people are freaked out about, ‘Oh my God, it’s going to eat the entire budget! It’s going to eat my personal budget. Health care and education is going to be every dollar I make as income, and it’s going to eat the national budget and drive the United States bankrupt!’ And everybody in the economy is going to become either a nurse or teacher. Both sides of the economy get polar opposite emotional reactions.”

Today’s technology advances often produce efficiency improvements which in turn produce lower costs, which translates into lower spending and measured GDP. More is being done with less and yet traditional measurements say that productivity is decreasing since less money is being spent in more productive sectors. In addition, many people assume that innovation always creates more producer surplus and profit. Charlie Munger describes the reality: “The great lesson in microeconomics is to discriminate between when technology is going to help you and when it’s going to kill you. And most people do not get this straight in their heads. There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.” These are confusing times, but that is no reason to adopt a pessimistic outlook on the potential of innovation to create enormously beneficial impacts. There is no question that today’s economy and the technological changes that power the economy have created a significant number of new problems like worker retraining that we must solve. We must discover new solutions to these new problems and this will require innovations of many kinds. Andreessen argues that we don’t have enough technological innovation: “With higher productivity growth, we’d have higher economic growth and more opportunity. But without enough opportunity, we’re all at risk on all sides of the ideological spectrum.”


A Dozen Lessons on Building a Business from Sarah Tavel


  1. “Ultimately when evaluating an early stage company, I say it’s a combination of art and science. The art is understanding how products work, the science is knowing how to measure it. The earlier the company, the more it is about art, which in this case is assessing what I think of the product and the use case.” 

Tavel is a great fit for Benchmark since the firm has always believed what they do is a craft. I wrote about this in my blog posts on Andy Rachleff, Peter Fenton and Bill Gurley. Fenton has said:

“because we love the day-to-day work with the entrepreneurs, [it] prevents us from scaling. We don’t have an ability to offload any part of our relationship in the way we practice it, to anyone other than ourselves. So, there’s no associates, no principals, there is really nothing beyond the group of people here and our assistants who keep our lives sane. That’s a strategy.”

What Benchmark partners like to do is invest early and work shoulder-to-shoulder with entrepreneurs. The Benchmark partners would use that approach even if it was not the best way to optimize their financial return since it is what they enjoy most about the process. The “art” of venture capital Tavel is referring to is often found in pattern recognition and that is highly related to good judgment which often comes from first party bad judgment or what Will Rogers once called watching other people pee on an electric fence (third party band judgement). It is important to note that a critically important part of the pattern recognition in venture capital is finding the exception to previous patterns that is different. Part of the pattern is: some rule that other people preciously believed was important is being broken by the best startups, but some rules that other people thought were important are being followed. It is a bit like the spot the difference game, except it must be a very important difference that delivers significant new core value to a really big market.

I have written about the science part of the entrepreneurial process quite a bit lately. Generating growth in a startup is accelerated by great data science because it allows you to measure results and apply the scientific method to growth experiments. When founders get access to great data science they have a greater ability to scale their output and most importantly make their creative contribution enduring. Data science does not eliminate the need for creative sparks, but when used effectively it facilitates creativity by enabling rigorous experimentation and increases the impact and growth of the business.    

  1. “For seed investments, it’s always first team, and second, believing in what they’re doing (as early as it is). I’ve passed on opportunities that had amazing teams, but I just couldn’t get behind what they were doing, for whatever reason. It doesn’t feel authentic to me to just make an investment on #1, if I’ll spend our conversations together trying to convince them that they should change #2. So really both need to line up for me.”

One of the reasons I write about so many different venture capitalists is to make the point by example that there is no cookie cutter way to be successful investing in startups. There are many similarities and common elements, but many differences too. My view is that there are different pools of alpha and different people search for that alpha in different ways. Of course, some investors are more successful than others. Typically the investors that are most successful chose an approach that is most consistent with their nature and unique skills. Benchmark co-founder Bruce Dunlevie puts the strength of the team at the top of the early stage investing hierarchy. Another Benchmark co-founder Andy Rachleff puts more emphasis on the existence of a very large addressable market. Of course, this is a matter of emphasis as both the right team and the right market are important. That Benchmark has adopted a craft rather than a platform approach to their business does not mean that other approaches by other venture capitalists do not work. It is just the right approach for them as individuals and gives then a unique service to offer founders.  Some founders will be more comfortable with a full service venture capital platforms. Some will not. Vive la différence. Strategy is what you do differently than your competitors. You must be different and you must be right about that difference if the strategy is going to be successful. 

  1. “Spend money very very carefully until you have product market fit. You want as lean a team as possible before you get there. There is no point of hiring more than the bare minimum team (usually just the co-founders) before you figure out what users want. Then you scale. Companies that hire before that waste runway, and that’s a shame. Once you have product market fit, you still need to be careful with hiring. 

The critical point Tavel is making is that it make no sense to pursue a growth hypothesis before the company has solved the value hypothesis. Why would you try to get more people to use a product that does not have core product value? It is not only hard to create core product value but the discovery process (if it happens) inevitably requires time and experimentation. The shorter the financial runway of the business the less opportunity exists for the startup to discover product market fit and solidify its value hypothesis. Tavel also notes that hiring is something to be approached with care even after the value hypothesis is proven. Early hires are particularly important as they create the business’ DNA place much more than later hires. Company culture is far more a determinant of success than people imagine. 

  1. “Another thing I see is scaling too quickly, particularly for local businesses. I see a lot a company launch something in one city, and before they’ve figured out the playbook, launch a bunch of other cities which burns through their cash, without really figuring out how to make it work in any one city.” 

Benchmark’s Bill Gurley has said: “We like to say that ‘more startups die of indigestion than starvation.’” One cause of death by indigestion is premature scaling of a growth hypothesis that has not been proven. Putting fuel in a rocket which does not have an attractive target and a working guidance system is a bad idea. Even if there is product market fit, there is a right time to spending big on generating growth and that time if after a sound growth hypothesis has been proven. 

  1. “I’d say that companies that have the greatest chances of becoming sustainable unicorns have incredibly strong network effects or economies of scale. More often than not, you find this with platforms/marketplaces, but not always. e.g., companies like Amazon or big banks, have very strong economies of scale, that make it very difficult to compete. But they take an enormous amount of capital to build.” 

Tavel is pointing out that the primary means of defending a business against competitors today is network effects. My blog post on network effects is here. Other approaches that can create a barrier to entry like economies of scale, regulatory expertise, intellectual property and brand still matter, but they are relatively less important than they once were, especially in the case of software startups. Economies of scale are desirable and complement network effects in many cases, but Tavel is pointing out that they are not “capital light.” One of the big changes in the business world that Charlie Munger and Warren Buffett talked about at the recent Berkshire meeting was the appearance of technology businesses that do not require much capital.

  1. Growing users without growing users completing the core action is the empty calories of growth. It feels good, but it’s not good for you. What is a core action? The action that is the very foundation and essence of your product. Pinterest would not exist without pinning. Twitter would not exist without tweeting.” 

There are a number of terms used to describe the factors that can create sustainable growth. One term that I like is the concept core product value, which represents a solution a real and significant problem that is valuable enough to cause people to want to pay for a product. Core product value is first recognized when the customer connects with the product in what is known as a “magic moment.” A magic moment is a realization or reaffirmation by a customer that a product has core product value. Tavel is saying that that a “core action” is what the customer does to realize core value.

There are different types of magic moments. My taxonomy is as follows:

  1. Hook magic moment – a realization of core product value that occurs within the first 15 seconds of customer on boarding that creates retention. There should be as little friction as possible in getting the visitor to the Hook magic moment as fast as possible.  Delivering the core experience quickly without overwhelming the visitor with features and sign up requirements is critical. For example, Alex Schultz of Facebook explains:

“[if you want] people to buy an item on eBay, should I land them on the registration page or the search results page?” You’d probably land them on the search results page, and that would get them to that magic moment faster. What is the moment when you used AirBnB? What  is the moment when you used DoorDash, when you used Slack, when you used Facebook,  LinkedIn, WhatsApp? Whatever the product, what is that moment when you went, ‘Yes. I’ve got  it.’ On Facebook it’s friends. Getting  that first person reserve your house, staying at that first property, those are our magic  moments. eBay, buying your first item from a stranger online.”

Scott Belsky describes the objective:

“Just one example: At Behance, in the sign-up process for our service, we used to ask new Behance members to select their top three creative fields. New users took an average of 120 seconds to browse the list and select their top fields. We lost around 10% of new members at this particular step in the sign-up process. And so, we removed it from the sign-up process and resolved ourselves to capture this information later on during active use of the website. As a result, sign-ups went up. This is true for every online service or store. In the first 15 seconds, your visitors are lazy in the sense that they have no extra time to invest in something they don’t know. They are vain in that they want to look good quickly using your product. And they’re selfish in that, despite the big picture potential and purpose of what your service.”

  1. Critical mass magic moment–  a realization of core product value that is strong enough to ensure that customers are retained over the long term. To determine whether retention has reached a critical mass. A Bain study concluded:

“Depending on which study you believe, and what industry you’re in, acquiring a new customer is anywhere from five to 25 times more expensive than retaining an existing one. It makes sense: you don’t have to spend time and resources going out and finding a new client — you just have to keep the one you have happy. If you’re not convinced that retaining customers is so valuable, consider research done by Frederick Reichheld of Bain & Company (the inventor of the net promoter score) that shows increasing customer retention rates by 5% increases profits by 25% to 95%.”

  1. Reinforcing magic moments–  customers experiencing “core product value” reinforcement while experiencing the product. An example of this approach happens when Facebook sends you a message that someone has tagged you in a photo. The intent is to harness your curiosity to drive you back to core product value. For Facebook, reinforcing magic moments include adding a friend, liking or sharing a post, or updating your status within 24 hours of downloading the mobile app. Chamath Palihapitiya believes you can create loops that expose that core product value over and over again. he says:  “You have to work backwards from ‘what is the thing that people are here to do?’ ‘What is the A-ha moment that they want?” Schultz cautions:There’s a really fine line between removing friction and duping users. Tricking users hurts users. Adding friction hurts users.”
  2. Reactivation magic moments–  experiences that cause a customer to returns to a service after being inactive. “We missed you” emails are intended to trigger this type of Magic Moment.

How do you discover magic moments for your service? The objective is to look for correlations between usage, demographics and other behavior and retention. Examples of magic moments discovered by some businesses include adding seven friends in ten days or sending several thousand messages.

  1. “Virtuous loops are the flywheels that covert your users’ engagement into fuel to power your company forward. The strongest virtual loop is a network effect. Virtuous loops are really hard to create. Most products don’t have them.”

Virtuous circles and vicious circles are processes which can reinforce themselves through a feedback loop. Virtuous circles produce feedback that results in an increasingly positive outcome and vicious circles the inverse of that. One famous picture of a flywheel at work that you see a lot is this one below which describes one aspect of Amazon’s business:

AMZN loop

  1. “To get the flywheel spinning for a marketplace, you can’t sit in front of your computer and code. You need to pound the pavement more often than not and do things ‘that don’t scale’ to get the liquidity to help you start scaling.” 

Y Combinator co-founder Paul Graham describes what a business must do to start a business from a standing start better that just about anyone I have seen: 

The most common unscalable thing founders have to do at the start is to recruit users manually. Nearly all startups have to. You can’t wait for users to come to you. You have to go out and get them. A good metaphor would be the cranks that car engines had before they got electric starters. Once the engine was going, it would keep going, but there was a separate and laborious process to get it going.”

There is a big difference between doing things that don’t scale and being in a business that won’t eventually scale. Scalability is an important goal for any business but almost always in the beginning efforts  will be require that don’t scale well.  CEOs will go on sales calls, products will be created by hand, and many manual processes will be used at first. This info-graphic captures some non-scalable approaches that startups have used to bootstrap their flywheels past the cold stat problem.


  1. In non-transactional products, real value will be created when you create accruing benefits.  A product has accruing benefits if a user would say the more I use the product, the better it gets.’” 

Tavel uses examples from her experience at Pinterest to make this point:


10. “Mounting loss happens as a product becomes something you depend on, part of your identity, or a product in which you’ve accrued value of some sort (e.g., a following). ‘I’d have a lot to lose if I left this product’ is the claim to test.”


11. “The clearest way to understand a company’s engagement is to look at cohorts: number of weekly users completing the core action and percentage of weekly active users completing the action.”

There are an endless number of ways you can think about cohorts. One simple approach to illustrate what can be done is to look at a cohort’s behavior graphically: the number of days from acquisition is on the x axis, on the y axis is the percent of people who are still monthly active. With each day that passes some members of the cohort will stop using the service but the critical mass objective is to get the curve to “flat line” in a way that asymptotes with the x axis. What causes the line to stop dropping is often the network effects of more people being on the network creating a critical mass of value for the customer.

A retention curve that does not flatten and instead drops to zero may be caused by a product market fit problem or it may be the nature of the product (e.g. some video games). The single most important factor that drives growth is retention.


12. “Blogging is venture capital’s freemium model.”

There are at least three reasons that venture capitalist’s write for public consumption.

  1. It helps the writer think things through and find new solutions and ways to communicate ideas.
  2. It is way to give back- teaching is a way of giving back.
  3. It is way to use content marketing to source new deal flow.

It’s always nice when you get three things for the same amount of effort. It is even better if you can do well financially by doing something good for other people. Regardless of whether someone is first starting out or even if they are a big success writing is a way to turn thinking, words and effort into a substitute for capital. Content marketing is both more capital efficient and produces better results than traditional marketing. 

Writing is my way of giving back. Revenue is negative. It makes me feel good though, which is highly underrated.


The Hierarchy of Engagement, expanded

How To Create A Sticky Product Like Facebook and Evernote 

How to build an enduring, multi-billion dollar business 

Engagement Hierarchy: Core Actions 

Venture Capital’s Freemium Model 

Growth Hackers AMA

Lesson from Scaling Pinterest

The Mitochondria of Startups

20 Minute VC

Graham- Do Things that Don’t Scale



Alex Schultz:


A Dozen Lessons about Money and Investing from Kendrick Lamar (K-Dot)


  1. “What I’ve learned is the best thing I can do with the position I’m in, and the places I’ve gone, is sharing this same information and giving you a step by step guide on the do’s and don’ts of what I’ve gained from talking to Jay Z and these different moguls in the business — whether talking about business, or just life. I can’t keep all of the information to myself, I have to share it. Within doing that, it’s giving me just as much as it’s giving them, and that’s worth more than any dollar amount.” Forbes Interview.

K-Dot is making the same point Charlie Munger was trying to convey when he said: “The best thing one human being can do for another human being is to help them know more.” Trying to figure out everything in life by yourself from first principles not only does not scale well, but it involves lots of unnecessary pain. Life gets easier when you learn vicariously from the mistakes of other people. You can do this by watching other people’s behavior or by reading about it. Munger advises: “I believe in the discipline of mastering the best that other people have figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.” K-Dot is also saying that an approach to life that includes teaching other people inevitably means you get back more than you give (e.g., the process of teaching anything makes you learn the topic even better). The other factor involved is what Munger has referred to as “penance.” Mohammad Ali  made a similar point once when he said: “Service to others is the rent you pay for your room here on earth.” Giving back to other people is not just beneficial because you learn more, it is by itself a moral imperative. 

  1. “If you get your first big check and you cop a chain before you buy a house. You’re a vanity slave.” Vanity Slave.

K-Dot is cautioning people to stay grounded about priorities, especially when fortune suddenly arrives. Vanity, greed and ego can cause people to make bad choices. He makes his point with an example: copping a chain before you take care of other basic needs is vanity. Concern about the adverse impact of vanity is not a new idea. For example, Jane Austen wrote: “Vanity and pride are different things, though the words are often used synonymously. A person may be proud without being vain. Pride relates more to our opinion of ourselves, vanity to what we would have others think of us.” I would rather put a viper down my shirt than let someone else determine whether I am happy. Getting control of your desire for ever more stuff is mentally healthy. Seneca once said: “It is not the man who has little, but he who desires more, that is poor.” In contrast, being ever covetous despite gains in wealth only increases the probability that you will be miserable. Can you be wealthy and enjoy that but not tie your happiness to maintaining that wealth? Seneca believed: “For many men, the acquisition of wealth does not end their troubles, it only changes them and that “Wealth is the slave of a wise man. The master of a fool.” The best thing you can acquire with money is independence. Munger puts it this way:  “Like Warren, I has a considerable passion to get rich, not because I wanted Ferarris.  I wanted the independence. I desperately wanted it.”

  1. “A dependable savings and you’ll retire with money in your account.” The Lonely Island.

People involved in the entertainment and sports industries often have incomes that are front loaded in the early years of their career. Yes, they can work at another job later in life, but that work may not pay nearly as much as they earned in their prime years. K-Dot is saying that adopting an approach which paces consumption over a person’s entire life is wise. The best way to increase your wealth is to save more of your income. Morgan Housel puts it this way:

“Building wealth has little to do with your income or investment returns, and lots to do with your savings rate. Fortunes can be blown as fast as they’re earned – and often are – while others with modest incomes can build up a fortune over time. Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income but have no chance without a high savings rate, it’s clear which one matters more.”

K-Dot is saying that people should think more about their retirement savings in particular. As just one example of what can happen if you do not save,  among senior beneficiaries in the US, the median Social Security benefit is $14,400. Trying to live on just that income given health care and other expenses is a terrible idea if you can avoid it. Here is some data on that point:

 soc sec

  1. “Take no chances, stop freelancin’; Invest in your future, don’t dilute your finances.” The Lonely Island.

While saving money is the most important step one can take to increase wealth and security, K-Dot is saying that investing is important too. The statistics on where many people stand on people’s financial preparation for retirement are dire. For example, “~1/2 of families have no retirement account savings at all. Median values are low for all age groups.” …


  1.  “401K, make sure it’s low risk.” The Lonely Island. “At 27, my biggest fear was losin’ it all.” Fear.

K-Dot is talking about the need for investors to control risk, especially when it comes to retirement funds in something like a 401K. Before a person can control risk it is necessary to define it. I particularly like the definition of risk adopted by Howard Marks: “In thinking about risk, we want to identify the thing that investors worry about and thus demand compensation for bearing. I don’t think most investors fear volatility. In fact, I’ve never heard anyone say, ‘The prospective return isn’t high enough to warrant bearing all that volatility.’ What they fear is the possibility of permanent loss.” Warren Buffett recently told a story about someone worrying about having enough money in their retirement that is both relevant and amusing:

“I had an Aunt Katie here in Omaha… She worked really hard all her life, lived in a house she paid $8,000 for… Because she was in Berkshire she ended up — she lived to 97 — she ended up with a few hundred million and she would write me a letter every four, five months and she said, ‘Dear Warren, I hate to bother you, but am I going to run out of money?’ And I would write her back and I’d say, ‘Dear Katie, It’s a good question because if you live 986 years, you’re going to run out of money. And then about four or five months later, she would write me the same letter again. There’s no way in the world if you’ve got plenty of money that it should become a minus in your life.”

  1.   “Got real estate over there and hustle over here.” Enjoy.

K-Dot is saying that he will not lose focus on the hustle aspects of his life just because he has made real estate or other investments. Nothing generates wealth more reliably that a strong work ethic, a regular income combined with talent and a willingness to save and invest.  My view on actively investing real estate is heavily influenced by the advice my grandfather (a real estate developer) gave to my father the doctor. He said that my dad should leave active real estate investing to professionals. If my father desired exposure to real estate my grandfather suggested that he do so via a fund. He said that it was possible for my dad to become an expert active real estate investor but only if he treated it as a second career, found an area to specialize in and was passionate about it.  Here’s Munger on real estate:

“The trouble with real estate is that everybody else understands it.  And the people who you are dealing with and competing with, they’ve specialized in a little twelve blocks or a little industry.  They know more about the industry than you do.  So you’ve got a lot of bull-shitters and liars and brokers.  So it’s not a bit easy.  It’s not a bit easy.  You don’t even see the good offerings in real estate.  It’s not an easy game to play from a beginner’s point of view.  Real estate.  Whereas with stocks, you’re equal with everybody.  If you’re smart.  In real estate, you don’t even see the opportunities when you’re a young person starting out.  They go to others.  The stock market’s always open.  It’s (like) venture capital.  Sequoia sees the good stuff.  You can open an office, “Joe Schmoe Venture Capitalists: Start-ups come to me!”  You’d starve to death.  You got to figure out what your competitive position is in what you’re choosing.  Real estate has a lot of difficulties.}

  1. “When you’re in this situation with all the lights on you, you’re going to get a lot of offers thrown at you, but if it’s not something that you see has longevity in it, you have to pass it up.” 

K-Dot knows that there are no called strikes in investing. Patience is essential as is waiting for the right offer. Opportunity cost is a huge filter in life. Charlie Munger looks at his investing decisions in this way: “We’re guessing at our future opportunity cost. Warren is guessing that he’ll have the opportunity to put capital out at high rates of return, so he’s not willing to put it out at less than 10% now. But if we knew interest rates would stay at 1%, we’d change. Our hurdles reflect our estimate of future opportunity costs. Warren is scanning the world trying to get his opportunity cost as high as he can so that his individual decisions are better.”

  1. “On the business end, it just shows me: always be critical and smart about the moves you make.”

K-Dot is pointing out that it is important to think critically about your decisions since we all have a range of dysfunctional biases that can tend to result in unwise decisions. Everyone makes mistakes. Thinking hard about how you might have made a mistake due to an emotional or dysfunctional factor can pay big dividends. People who can put aside their ego-based defenses and embrace a great idea that someone else discovered tend to get better results in life. “Not invented here” too often means “no benefits here.” Charlie Munger said exactly that the 2017 Berkshire shareholders meeting: “You have to have a habit of reexamining your old ideas from time to time since without that, you can’t see it when they become wrong. A year in which you do not change your mind about something important is a wasted year in his view.

  1. “So just to get a dollar, will I sell my soul? I look the Devil in the eye and tell him, hell no.” Compton State of Mind.

In the end you can make more money from behavior that meets a high ethical standard. Not only it is the right thing to do morally, it is the right thing to do from a profit standpoint. Charlie Munger has said: We don’t claim to have perfect morals, but at least we have a huge area of things that, while legal, are beneath us. We won’t do them.  Currently, there’s a culture in America that says that anything that won’t send you to prison is OK.” What can be more satisfying than doing well financially while at the same time making a positive contribution to society in a way that is highly ethical? Munger tells a story about how he made a fantastic investment by wading into an area where the other people involved are ethically challenged:

“I soon realized that under the peculiar rules of an idiot civilization, the only people who were going to bid for these oil royalties were oil royalty brokers who were a scroungy, dishonorable, cheap bunch of bastards. I realized that none of them would ever bid a fair price.”

  1. “All money ain’t good money.”

K-Dot is channeling a point Dorothy Parker famously made when she said: “If you want to know what God thinks of money, just look at the people he gave it to.” It is that simple.  Munger puts it this way:

“Ben Franklin said: ‘I’m not moral because it’s the right thing to do – but because it’s the best policy.’” “We  knew early how advantageous it would be to get a reputation for doing the right thing and it’s worked out well for us. My friend Peter Kaufman, said ‘if the rascals really knew how well honor worked they would come to it.’ People make contracts with Berkshire all the time because they trust us to behave well where we have the power and they don’t. There is an old expression on this subject, which is really an expression on moral theory: ‘How nice it is to have a tyrant’s strength and how wrong it is to use it like a tyrant.’ It’s such a simple idea, but it’s a correct idea.” “You’ll make more money in the end with good ethics than bad. Even though there are some people who do very well, like Marc Rich–who plainly has never had any decent ethics, or seldom anyway. But in the end, Warren Buffett has done better than Marc Rich–in money–not just in reputation.”

  1. “The best thing I’ve learned is that it’s not about getting a certain amount of dollars and spreading it all out. That process is meant to crumble. That process is meant to bring envy and hate, because once you stop spreading it, or once you stop getting it, you realize there’s just a lot of evil behind it.”

No matter how rich someone like K-Dot may become there are limits to what can be given away. Problems are inevitably created when too much money is given away to a friend or a posse of friends. K-Dot is saying that people who were on the receiving end of gifts have a tendency to get angry if you stop since they feel they have lost something. These angry feelings are heightened due to loss aversion.  Being generous works better when you make sure that the beneficiary is not acquiring an expectation that the gifts will be ongoing. Being generous of charitably minded is not always simple. This is K-Dot in “How Much a Dollar Cost” from the album “To Pimp a Butterfly”:

“…Walked out the gas station
A homeless man with a silly tan complexion
Asked me for ten grand
Stressin’ about dry land
Deep water, powder blue skies that crack open
A piece of crack that he wanted, I knew he was smokin’
He begged and pleaded
Asked me to feed him twice, I didn’t believe it
Told him, “Beat it”
Contributin’ money just for his pipe, I couldn’t see it
He said, “My son, temptation is one thing that I’ve defeated
Listen to me, I want a single bill from you
Nothin’ less, nothin’ more
I told him I ain’t have it and closed my door
Tell me how much a dollar cost

It’s more to feed your mind
Water, sun and love, the one you love
All you need, the air you breathe

He’s starin’ at me in disbelief
My temper is buildin’, he’s starin’ at me, I grab my key
He’s starin’ at me, I started the car and tried to leave
And somethin’ told me to keep it in park until I could see
A reason why he was mad at a stranger like I was supposed to save him…”

  1. “It’s one thing we’ll keep coming back to — remove the ego. I promise you, that’s the most valuable thing I’ve learned.”

Morgan Housel puts it this way:one of the most powerful ways to increase your savings isn’t to raise your income, but your humility.” Morgan knows that ego can easily get in the way of making sound decisions. As I noted in my recent blog post on Ray Dalio, he believes: People are so attached to being right, and yet the tragedy is it could be so easy to find out how you’re wrong.” If you can learn to take ego out of your decision making  you will make fewer mistakes. Buying things and making investments that stroke your ego is short sighted. People who learn to save and invest have better choices in life. Few things are worse in life than having no choices. Munger with a closing thought:

“Then there’s the chasing of the investment return rabbit. What if you had an investment that you were confident would return 12% per annum. A lot of you wouldn’t like that — especially if you’ve done better– but many would say, ‘I don’t care if someone else makes money faster.’ The idea of caring that someone is making money faster is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?”


Morgan Housel:

Nassim Taleb:

The Dot-Com Boom and Bust


“Most of the entrepreneurs today weren’t around in ’99. They have no muscle memory of it whatsoever.” Bill Gurley (September 2016)

Unlike the entrepreneurs Bill Gurley is talking about, I have a lot of muscle memory that resulted from the Internet bubble. There is no way you can fully convey in words the experience being in the lead car as an investor in that roller coaster. Looking at the cycle after the fact is nothing like looking ahead and not knowing what will happen next. The experience still impacts the way I think and act. It was a heck of a lot of fun in some ways. If you can’t learn from an experience like we had in the markets during roller-coaster ride that was the Dot-Com phenomenon, you were not paying attention. Good judgment comes from experience and often that experience comes from bad judgment. Most of the bad judgment associated with the Dot-Com era was observed but some of it was mistakes I made all by myself or as part of a herd. It is hard to describe how strong the feeling of FOMO was at the time. People were terrified of missing out on the upside and loss aversion and paper gains made them reluctant to act to cushion the downside.

Every story must have a starting point. The best time to begin this tale is probably 1993 when the business environment first started to change in way that would develop into a bubble. Changes that we would look back at later and say “that was crazy” did not happen in a huge way at first. The initial buildup was gradual and steady at the outset. But by 1994 the parties started getting better, the tchotchkes more lavish and paper wealth created at an impressive pace. Everyone was a frog in a pot of boiling water but they mostly did not feel it. By 1995 having in the Rolling Stones or The Eagles play at a private party hosted by a bigwig was becoming normalized in some circles in certain geographies.

One aspect of the abnormality of the period was the rapid jump in the number of IPOs. This chart shows the “IPO pig coming through the snake” in the mid to late 1990s. It also puts the current IPO market into perspective.

Not Many IPOs

Venture backed IPOs looked like this chart below. One VC quoted on Bloomberg recently predicted 30-35 IPOs in 2017. As a benchmark for comparison, there were 21 tech IPOs in 2016, 23 in 15 and 55 in 2014 and 84 in 2013.


The amount of paper wealth that was being created did not start to accelerate to bonkers levels until ~1996. While 1996 had the most IPOs 1999 was the pivotal year in terms of the valuations and amounts of money raised:

money raised

One aspect of the IPO craziness of the Dot-Com era was the first day pop. Getting an allocation of “friends and family” shares for an IPO seemed to some people like a guaranteed way to make a profit in 1999. Like most bubble phenomenon that first day pop approach worked until it suddenly didn’t.

While the madness was going on there were people who predicted that a bubble was forming and that it would end badly; some of these people took their fund to $0 by shorting stocks too early. That experience illustrated how being early in making a prediction is indistinguishable from being wrong. By late 1999 I remember thinking “everyone can’t really be this rich. Or can they?” Some people became fabulously rich on paper in just months and the impact of that was that envy and jealousy which caused other people to lose their tie to reality. The environment was literally nuts. FOMO made people do things that in retrospect seem insane, but at the time seemed reasonable. Here’s a recap:

“Initial public offerings raised more than $69 billion in 1999, 39 percent more than 1996, the second-biggest year, according to Thomson Financial Securities Data. More eye-popping, however, may be the year’s record first-day gains. VA Linux jumped a record 733 percent in its first day of trading in early December. One hundred and seventeen, or 23 percent, of the year’s IPOs soared more than 100 percent in the first day of trading, according to The average first-day gains of 68 percent this year trounced last year’s average rise of 23 percent. The year registered nine of the top 10 first-day IPO gains of all-time, according to”


What happened to VA Linux?

changed it

Geeknet now sells classic items like:


A Salon article in April of 2000 article painted a picture of the party scene in the technology world that was produced by too much cash chasing too little value. What is most notable perhaps about the article is that it appeared after the bubble had popped. The party scene was operating on momentum still, but about to come to a calamitous halt.

“Jessica Crolick downs her free drink, grabs a black fleece jacket from the table and darts out of the dot-com party at the San Francisco Museum of Modern Art. She hops into a van with four strangers, who are on their way to another dot-com bash across town. The conversation moves from work to apartments, but conspicuously absent from the chatter is Digital Island the digital content delivery company that spent over $50,000 for food, drink and fleece to fete its new logo and announce a partnership with Apple. In fact, by the time Crolick and her posse reach the second party — a tropical-themed and more raucous affair hosted by Beenz an online currency company — few remember the first company’s name, and no one knows or cares what either company does. Dot-com valuations may have withered, but the enthusiasm for extravagant dot-com parties hasn’t, and party budgets show no signs of being trimmed. In any given week, technology companies throw 15 to 20 parties in the San Francisco Bay Area. On average, each costs $30,000 to $50,000, according to party planners and venue owners, although the $250,000 blowout is hardly rare. In March, for example, Salesforce an online sales automation service, and iCast which offers streaming media tools and content, each ran up tabs greater than $200,000, entertaining more than 1,000 guests each…. Marx, the president of Acteva — which brought 2,000 people to Treasure Island in December for a $200,000 party to announce its new name — agrees. More money, more people and more extravagant ideas are definitely the way to go. It’s no longer enough to just “get a few hundred people together and give them a drink,” he says, glancing around at the paltry WiredPlanet party.”

Clearly an abnormal number of IPOs and unprofitable companies doing an IPO was happening in 1999.

dist ipo

The level of schadenfreude and morbid curiosity was also unprecedented.  The roll call of craziness is long:






Blue Mountain











A more complete list of companies that went public during the DotCom era can be seen in this document entitled: “A Prelude to the Dot-Com Bust”  What is interesting is that a few companies like Amazon are on this list so some went on to bigger things. It would be interesting if the math revealed yet another power law.

One thing that is hard to describe is how quick things got really ugly. Some people froze like a deer in headlights. Other people acted and salvaged some value. Every day in the market even during less volatile times you are in the lead car of the a roller-coaster and can’t see anything ahead, but because the up and down motion were so very steep in the Dot-Com era the experience was particularly unnerving.

“On March 10, 2000 the combined values of stocks on the NASDAQ was at $6.71 trillion; the crash began March 11. By March 30, the NASDAQ was valued at $6.02 trillion. On April 6, 2000, it was $5.78 trillion.”

By the start of 2000 the investing and business environments weren’t quite as nutty as was the case in 1999 but times were still relatively good. But things went downhill fast that year:

“Unlike 1999, the new issues class of 2000 featured a lot of big losers,” says Richard Peterson, chief market strategist for Thomson Financial Securities Data. Peterson’s firm reports that of the 452 stocks that went public last year, 284, or 63%, trade below their offering prices and 68% are down from the first trading day’s close.

What caused the bubble to pop? In March of 2000 Barron’s carried a story that contained some sobering numbers that some people believe was pivotal in triggering the correction. I am of the views that what triggered the correction was a lack of cash. Was the Barron’s article the last straw on the camel’s back? It is impossible to prove but some people think so. I remember reading the Barron’s story but since I was seeing many Internet companies with little cash on hand the article’s conclusion was not really news. There were telecom companies on that list referred to in the Barron’s article but the telecom world did not see a collapse until early 2001. There were also companies on that list  like Amazon, Ticketmaster, McAfee and Priceline that survived. In any event, regardless of whether you think the article as the cause of the change, the Barron’s story was very timely and correct:

“An exclusive study conducted for Barron’s by the Internet stock evaluation firm Pegasus Research International indicates that at least 51 ‘Net firms will burn through their cash within the next 12 months. This amounts to a quarter ofthe 207 companies included in our study. Among the outfits likely to run out of funds soon are CDNow, Secure Computing, drkoop, Medscape, Infonautics, Intraware and Peapod. To assess the Internet sector’s financial position, Pegasus assumed that the firms in the study would continue booking revenues and expenses at the same rate they did in last year’s fourth quarter. While this method cannot predict the future precisely, it helps answer a question that has been nagging many stock-market analysts: When will the crowded Internet industry begin to be winnowed? The ramifications are far-reaching. To begin with, America’s 371 publicly traded Internet companies have grown to the point that they are collectively valued at $1.3 trillion, which amounts to about 8% of the entire U.S. stock market.”

These charts of the NASDAQ tell a graphical story about what happened and when. It is important to note that it went down as fast as it went up. One company as I recall ended up stuck with $1B in FPGA chips sitting in warehouses. Everything changed. Quickly. The telecom bubble took at bit longer to correct, but that is another story.


real price

By December 2000:

“What a difference a year makes. The Nasdaq sank. Stock tips have been replaced with talk of recession. Many pioneering dot-coms are out of business or barely surviving. The Dow Jones Internet Index, made up of dot-com blue chips, is down more than 72 percent since March. Online retailers Priceline and eToys, former Wall Street darlings, have seen their stock prices fall more than 99 percent from their highs.”

Philip J. “Pud” Kaplan’s operated a web site that published stories, internal memos and leaked documents of failed startups that still can be found at You can change the date to simulate what it was like to look at the dead pool every day. Posts looked like this:


In terms of my own decisions related to the end of the bubble, the summer of 1999 was when I hedged the market by selling some shares and buying some puts as a proxy hedge after reading a lot of material on the views of Buffett and Munger. I decided that year I would put away enough money in safe bets so I could live comfortably regardless of what happened. There are times in life when the world will not make much sense, at least to you. As an example, the Internet bubble of 1999-2001 was a time like that. The share sales and proxy hedging ensured that I would not be a burden to anyone in my retirement and that my children would be able to go to college with my financial assistance. I did leave a lot of money on the table by not selling everything, but my “barbell portfolio” did what it was designed to do. My decisions were not perfect but they were sound.


Little Risk (cash and safe bonds)                                   Lots of Risk (startups and tech stocks)

So you may ask, are we in a bubble now? Well we can say that things are very different. The situation today is not the same it was in March 2000. The Economist writes;

“the base of today’s success is broader. In 2000 some 400m people around the world had access to the internet; by the end of 2015 3.2 billion people will. And the internet reaches into these people’s lives in many more ways than it could 15 years ago. ‘Technology is no longer a vertical industry, as it’s been understood by everyone for four decades,’ says John Battelle, a journalist and entrepreneur who launched the Industry Standard, a magazine which reported on the dotcom boom before itself going bankrupt in 2001. ‘Technology is now a horizontal, enabling force throughout the whole economy.’”

I fall in the camp of people who say that we do not have a valuation bubble today but rather a risk bubble. The big lesson to take away from the 2000 bust is that the cash spigot can close really fast. One day you can raise hundreds of millions of dollars and the next day you can’t raise five cents. From the end of the Internet bubble into 2003 cash was indeed king. I remember Greg Maffei telling me that when he was still Microsoft’s CFO as early as 1998. Risk and valuation are not the same. There are many thing that are different now a few of which are noted in this article  by Burt White, Chief Investment Officer for LPL Financial

  • Price to Earnings Ratio (PE). The PE ratio for the Nasdaq in March 2000 on current year estimates was 107, versus 23 today. Even using the consensus forward (next 12 months) earnings estimates, the PE stood at 75 back in March 2000 compared with 22 today. The cash flow multiples also tell the same story: near 100 then compared with mid-20s now.
  • Price-to-book ratio. Valuation measures based on the value of company assets minus liabilities, or book value, also reveal a much more expensive Nasdaq in 2000 versus now. The lack of assets supporting valuations was a big problem during the dotcom bubble (page views, eyeballs, and clicks were not enough). The price-to-book ratio at the peak in March 2000 was over 7, compared with 3.9 now (as of April 28, 2017). And those assets today produce far more profits.
  • Market trajectory. Another way to compare today’s Nasdaq to the 2000 version is looking at the steepness of the two rallies, which reveals a dramatic difference. The Nasdaq has gained 22% over the past two years, compared to its 189% surge during the two years leading up to the March 10, 2000 peak. Clearly today’s technology rally lacks the parabolic nature of the dotcom bubble.

Good things can come from bad experience. Many ideas that failed then are succeeding now. Capitalism requires failure and it is an understatement to say that a lot of things failed as a result of the Internet bubble. One good example is described here by CB Insights:  “In 1996, Louis Borders, founder of Borders bookstores (a famous casualty of the modern e-commerce era), had the crazy idea to let people order their groceries online and have them delivered to their homes. To achieve this, Louis Borders raised $396 million through an IPO in late 1999. After several years of sustained losses, though, the company finally crashed in 2001. But Borders’ dream of people never having to leave their homes for groceries has since been adopted by Amazon.” I know several people who loved WebVan as customers and they mourned its demise. But they could not cover their costs (venture philanthropy does not scale) and ran out of cash.






10 years Gone: